UNITED STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 FORM
10-Q
  xQUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934
  For
the quarterly period ended March 31, 2010
  OR
   ̈TRANSITION
      REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
  For
the transition period from to
  Commission
File number 000-51358
  Kenexa
Corporation
 (Exact Name of Registrant as Specified in Its
Charter)
  Pennsylvania
                  (State
      or other jurisdiction of incorporation or organization)
                23-3024013
                  (I.R.S.
      Employer Identification Number)
  650
      East Swedesford Road, Wayne, PA
                  (Address
      of Principal Executive Offices)
                19087
                  (Zip
      Code)
  Registrant’s
Telephone Number, Including Area Code: (610) 971-9171
   Indicate by check mark whether the registrant: (1) has
filed all reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90
days.    Yes  x  No    ̈
  Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).    Yes ̈No ̈
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of “large accelerated filer”, “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.  (Check one):
 Large Accelerated Filer  ̈        
Accelerated Filer x        
Non-accelerated Filer  ̈         Smaller
reporting company  ̈
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes   ̈   No  x
  On May 4,
2010, 22,594,347 shares of the registrant’s Common Stock, $0.01 par value, were
outstanding.
  1
 Kenexa
Corporation and Subsidiaries
 FORM
10-Q
 Quarter
Ended March 31, 2010
 Table of Contents
   PART I: FINANCIAL
      INFORMATION
                
                PageItem
      I: Financial StatementsConsolidated Balance Sheets as of
      March 31, 2010 (unaudited) and December 31,
2009
                
                3Consolidated
      Statements of Operationsfor the
      three months ended March 31, 2010 and 2009
      (unaudited)
                
                4Consolidated
      Statements of Shareholders' Equityfor the three months ended March 31, 2010
      (unaudited)and the year ended December 31, 2009
                
                5Consolidated
      Statements of Cash Flowsfor the
      three months ended March 31, 2010 and 2009
      (unaudited)
                
                6Notes to
      Consolidated Financial Statements(unaudited)
                
                7Item 2: Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
                
                32Item 3: Quantitative and Qualitative Disclosures about
      Market Risk
                
                49Item 4: Controls and Procedures
                
                49PART
      II: OTHER INFORMATIONItem 1: Legal Proceedings
                
                50Item 1A: Risk Factors
                
                51Item 2: Unregistered Sales of Equity Securities and
      Use of Proceeds
                
                51Item 3: Defaults Upon Senior
    Securities
                
                51Item 4: Submission of Matters to a Vote of Security
      Holders
                
                51Item 5: Other Information
                
                51Item 6: Exhibits
                
                51Signatures
                
                52Exhibit Index
                
                53
   2
 Table of Contents
  PART
I FINANCIAL INFORMATION
 Item
1: Financial Statements
 Kenexa Corporation and Subsidiaries
 Consolidated Balance Sheets
 (In
thousands, except share data)
 
 March
      31,
                    2010
                  
                  
                  December
      31,
                    2009(unaudited)AssetsCurrent
      AssetsCash
      and cash equivalents
                  
                  $
                  38,302
                  
                  
                  $
                  29,221Short-term
      investments
                  
                  
                  24,252
                  
                  
                  
                  29,570Accounts
      receivable, net of allowance for doubtful accounts of $2,019 and $2,090,
      respectively
                  
                  
                  26,082
                  
                  
                  
                  26,782Unbilled
      receivables
                  
                  
                  3,355
                  
                  
                  
                  4,457Income
      tax receivable
                  
                  
                  1,630
                  
                  
                  
                  1,704Deferred
      income taxes
                  
                  
                  7,926
                  
                  
                  
                  8,685Prepaid
      expenses and other current assets
                  
                  
                  9,844
                  
                  
                  
                  8,428Total
      Current Assets
                  
                  
                  111,391
                  
                  
                  
                  108,847Property
      and equipment, net of accumulated depreciation
                  
                  
                  19,462
                  
                  
                  
                  19,530Software,
      net of accumulated amortization
                  
                  
                  18,148
                  
                  
                  
                  17,337Goodwill
                  
                  
                  3,664
                  
                  
                  
                  3,204Intangible
      assets, net of accumulated amortization
                  
                  
                  7,963
                  
                  
                  
                  9,143Deferred
      income taxes, non-current
                  
                  
                  34,911
                  
                  
                  
                  34,879Other
      long-term assets
                  
                  
                  10,121
                  
                  
                  
                  9,403Total
      assets
                  
                  $
                  205,660
                  
                  
                  $
                  202,343Liabilities
      and Shareholders' EquityCurrent
      liabilitiesAccounts
      payable
                  
                  $
                  5,644
                  
                  
                  $
                  5,727Notes
      payable, current
                  
                  
                  6
                  
                  
                  
                  16Commissions
      payable
                  
                  
                  1,127
                  
                  
                  
                  671Accrued
      compensation and benefits
                  
                  
                  3,284
                  
                  
                  
                  4,820Other
      accrued liabilities
                  
                  
                  6,192
                  
                  
                  
                  6,376Deferred
      revenue
                  
                  
                  54,504
                  
                  
                  
                  49,964Capital
      lease obligations
                  
                  
                  208
                  
                  
                  
                  211Total
      current liabilities
                  
                  
                  70,965
                  
                  
                  
                  67,785Capital
      lease obligations, less current portion
                  
                  
                  208
                  
                  
                  
                  259Deferred
      income taxes
                  
                  
                  226
                  
                  
                  
                  850Other
      liabilities
                  
                  
                  1,979
                  
                  
                  
                  1,981Total
      liabilities
                  
                  
                  73,378
                  
                  
                  
                  70,875Commitments
      and ContingenciesTemporary
      EquityNoncontrolling
      interest
                  
                  
                  1,393
                  
                  
                  
                  1,330Shareholders'
      EquityPreferred
      stock, par value $0.01; 10,000,000 shares authorized; no shares
      issued
                    or outstanding
                  
                  
                  —
                  
                  
                  
                  —Common
      stock, par value $0.01; 100,000,000 shares
      authorized;  22,593,922 and 22,561,883 shares issued and
      outstanding, respectively
                  
                  
                  226
                  
                  
                  
                  226Additional
      paid-in-capital
                  
                  
                  276,616
                  
                  
                  
                  275,127Accumulated
      deficit
                  
                  
                  (141,730
                  )
                  
                  
                  (141,712
                  )Accumulated
      other comprehensive loss
                  
                  
                  (4,223
                  )
                  
                  
                  (3,503
                  )Total
      shareholders' equity
                  
                  
                  130,889
                  
                  
                  
                  130,138Total
      liabilities and shareholders' equity
                  
                  $
                  205,660
                  
                  
                  $
                  202,343
  See
notes to consolidated financial statements.
  3
 Table of Contents
  Kenexa Corporation and Subsidiaries
 Consolidated Statements of Operations
 (In
thousands, except share and per share data)
 (unaudited)
  Three
      Months Ended
                  March
      31,2010
                
                
                2009Revenues:Subscription
                
                $
                33,252
                
                
                $
                33,265Other
                
                
                6,412
                
                
                
                5,566Total
      revenues
                
                
                39,664
                
                
                
                38,831Cost
      of revenues
                
                
                13,811
                
                
                
                13,696Gross
      profit
                
                
                25,853
                
                
                
                25,135Operating
      expenses:Sales
      and marketing
                
                
                9,640
                
                
                
                8,705General
      and administrative
                
                
                9,831
                
                
                
                10,873Research
      and development
                
                
                2,284
                
                
                
                2,568Depreciation
      and amortization
                
                
                4,036
                
                
                
                3,228Goodwill
      impairment charge
                
                
                —
                
                
                
                33,329Total
      operating expenses
                
                
                25,791
                
                
                
                58,703Income
      (loss) from operations
                
                
                62
                
                
                
                (33,568
                )Interest
      income
                
                
                146
                
                
                
                63Loss
      on change in fair market value of ARS and put option, net
                
                
                (31
                )
                
                
                (295
                )Income
      (loss) before income taxes
                
                
                177
                
                
                
                (33,800
                )Income
      tax expense
                
                
                133
                
                
                
                482Net
      income (loss)
                
                
                44
                
                
                
                (34,282
                )Income
      allocated to noncontrolling interests
                
                
                (62
                )
                
                
                —Net
      loss allocable to common shareholders
                
                $
                (18
                )
                
                $
                (34,282
                )Basic
      net loss per share
                
                $
                0.00
                
                
                $
                (1.52
                )Weighted
      average shares used to compute net loss allocable to common shareholders
      per share – basic
                
                
                22,577,266
                
                
                
                22,509,304Diluted
      net loss per share
                
                $
                0.00
                
                
                $
                (1.52
                )Weighted
      average shares used to compute net loss allocable to common shareholders
      per share – diluted
                
                
                22,577,266
                
                
                
                22,509,304
  See
notes to consolidated financial statements.
   4
 Table of Contents
  Kenexa Corporation and Subsidiaries
 Consolidated Statements of Shareholders' Equity
 (in
thousands)
  Common
                  stock
                
                Additional
      paid-in capital
                
                Accumulated
      deficit
                
                
                Accumulated
      other comprehensive
                  loss
                
                
                Total
                  shareholders'
                  equity
                
                
                Comprehensive
                  lossBalance,
      December 31, 2008
                
                $
                225
                
                $
                269,365
                
                $
                (110,633
                )
                
                $
                (2,421
                )
                
                $
                156,536
                
                
                $
                (108,520
                )Loss
      on currency translation adjustments
                
                
                —
                
                
                —
                
                
                —
                
                
                
                (925
                )
                
                
                (925
                )
                
                
                (925
                )Unrealized
      loss on short-term investments
                
                
                —
                
                
                —
                
                
                —
                
                
                
                (157
                )
                
                
                (157
                )
                
                
                (157
                )Share-based
      compensation expense
                
                
                —
                
                
                5,364
                
                
                —
                
                
                
                —
                
                
                
                5,364
                
                
                
                —Option
      exercises
                
                
                —
                
                
                70
                
                
                —
                
                
                
                —
                
                
                
                70
                
                
                
                —Employee
      stock purchase plan
                
                
                1
                
                
                328
                
                
                —
                
                
                
                —
                
                
                
                329
                
                
                
                —Income
      allocated to noncontrolling interest
                
                
                —
                
                
                —
                
                
                (61
                )
                
                
                —
                
                
                
                (61
                )
                
                
                (61
                )Net
      loss
                
                
                —
                
                
                —
                
                
                (31,018
                )
                
                
                —
                
                
                
                (31,018
                )
                
                
                (31,018
                )Balance,
      December 31, 2009
                
                
                226
                
                
                275,127
                
                
                (141,712
                )
                
                
                (3,503
                )
                
                
                130,138
                
                
                
                (32,161
                )Loss
      on currency translation adjustments
                
                
                —
                
                
                —
                
                
                —
                
                
                
                (602
                )
                
                
                (602
                )
                
                
                (602
                )Unrealized
      loss on short-term investments
                
                
                —
                
                
                —
                
                
                —
                
                
                
                (118
                )
                
                
                (118
                )
                
                
                (118
                )Share-based
      compensation expense
                
                
                —
                
                
                1,291
                
                
                —
                
                
                
                —
                
                
                
                1,291
                
                
                
                —Option
      exercises
                
                
                —
                
                
                102
                
                
                —
                
                
                
                —
                
                
                
                102
                
                
                
                —Employee
      stock purchase plan
                
                
                —
                
                
                96
                
                
                —
                
                
                
                —
                
                
                
                96
                
                
                
                —Income
      allocated to noncontrolling interest
                
                
                —
                
                
                —
                
                
                (62
                )
                
                
                —
                
                
                
                (62
                )
                
                
                (62
                )Net
      income
                
                
                —
                
                
                —
                
                
                44
                
                
                
                —
                
                
                
                44
                
                
                
                44Balance,
      March 31, 2010 (unaudited)
                
                $
                226
                
                $
                276,616
                
                $
                (141,730
                )
                
                $
                (4,223
                )
                
                $
                130,889
                
                
                $
                (738
                )
  See
notes to consolidated financial statements.
   5
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Consolidated Statements of Cash Flows
 (in
thousands)
 (unaudited)
 Three
      months ended
                    March
      31,2010
                  
                  
                  2009Cash
      flows from operating activitiesNet
      income (loss)
                  
                  $
                  44
                  
                  
                  $
                  (34,282
                  )Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activitiesDepreciation
      and amortization
                  
                  
                  4,036
                  
                  
                  
                  3,228Loss
      on disposal of property and equipment
                  
                  
                  34
                  
                  
                  
                  —Loss
      on change in fair market value of ARS and put option, net
                  
                  
                  31
                  
                  
                  
                  295Goodwill
      impairment charge
                  
                  
                  —
                  
                  
                  
                  33,329Share-based
      compensation expense
                  
                  
                  1,291
                  
                  
                  
                  1,245Amortization
      of deferred financing costs
                  
                  
                  —
                  
                  
                  
                  75Bad
      debt recoveries
                  
                  
                  (41
                  )
                  
                  
                  (45
                  )Deferred
      income tax expense (benefit)
                  
                  
                  143
                  
                  
                  
                  (825
                  )Changes
      in assets and liabilities, net of business combinationsAccounts
      and unbilled receivables
                  
                  
                  1,362
                  
                  
                  
                  5,239Prepaid
      expenses and other current assets
                  
                  
                  (1,859
                  )
                  
                  
                  (1,083
                  )Income
      taxes receivable
                  
                  
                  74
                  
                  
                  
                  36Other
      long-term assets
                  
                  
                  (821
                  )
                  
                  
                  332Accounts
      payable
                  
                  
                  (80
                  )
                  
                  
                  (715
                  )Accrued
      compensation and other accrued liabilities
                  
                  
                  (523
                  )
                  
                  
                  (338
                  )Commissions
      payable
                  
                  
                  460
                  
                  
                  
                  (180
                  )Deferred
      revenue
                  
                  
                  4,655
                  
                  
                  
                  2,569Net
      cash provided by operating activities
                  
                  
                  8,806
                  
                  
                  
                  8,880Cash
      flows from investing activitiesCapitalized
      software and purchases of property and equipment
                  
                  
                  (3,581
                  )
                  
                  
                  (2,997
                  )Purchase
      of available-for-sale securities
                  
                  
                  (730
                  )
                  
                  
                  (845
                  )Sale
      of available-for-sale securities
                  
                  
                  2,255
                  
                  
                  
                  1,203Sale
      of trading securities
                  
                  
                  4,050
                  
                  
                  
                  1,150Acquisitions
      and variable interest entity, net of cash acquired
                  
                  
                  (1,635
                  )
                  
                  
                  (1,730
                  )Net
      cash provided by (used in) investing activities
                  
                  
                  359
                  
                  
                  
                  (3,219
                  )Cash
      flows from financing activitiesRepayments
      of notes payable
                  
                  
                  (9
                  )
                  
                  
                  (8
                  )Repayment
      of capital lease obligations
                  
                  
                  (54
                  )
                  
                  
                  (53
                  )Proceeds
      from common stock issued through Employee Stock Purchase
    Plan
                  
                  
                  96
                  
                  
                  
                  78Net
      proceeds from option exercises
                  
                  
                  102
                  
                  
                  
                  —Net
      cash provided by financing activities
                  
                  
                  135
                  
                  
                  
                  17Effect
      of exchange rate changes on cash and cash equivalents
                  
                  
                  (219
                  )
                  
                  
                  (375
                  )Net
      increase in cash and cash equivalents
                  
                  
                  9,081
                  
                  
                  
                  5,303Cash
      and cash equivalents at beginning of period
                  
                  
                  29,221
                  
                  
                  
                  21,742Cash
      and cash equivalents at end of period
                  
                  $
                  38,302
                  
                  
                  $
                  27,045Supplemental
      disclosures of cash flow informationCash
      paid during the period for:Interest
      expense
                  
                  $
                  4
                  
                  
                  $
                  15Income
      taxes
                  
                  $
                  272
                  
                  
                  $
                  925
  See
notes to consolidated financial statements
  6
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notesto Consolidated Financial Statements -
Unaudited
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   1.
Organization
  Kenexa
Corporation, and its subsidiaries (collectively the "Company" or “Kenexa”),
commenced operations in 1987 as a provider of recruiting services to a wide
variety of industries.  In 1993, the Company offered its first
automated talent management system.  Between 1994 to 2009 the Company
acquired 28 businesses that enabled it to offer comprehensive human capital
management, or HCM, services integrated with web-based
technology.  The Company’s business solutions include a comprehensive
suite of on-demand software applications and complementary services, including
outsourcing services and consulting, to help global organizations recruit high
performing individuals and to foster optimal work environments to increase
employee productivity and retention.
  The
Company began its operations in 1987 under its predecessor companies, Insurance
Services, Inc., or ISI, and International Holding Company, Inc., or
IHC. In December 1999, the Company reorganized its corporate structure by
merging ISI and IHC with and into Raymond Karsan Associates, Inc., or RKA,
a Pennsylvania corporation and a wholly owned subsidiary of Raymond Karsan
Holdings, Inc., or RKH, a Pennsylvania corporation. Each of RKA and RKH
were newly created to consolidate the businesses of ISI and IHC. In
April 2000, the Company changed its name to TalentPoint, Inc. and
changed the name of RKA to TalentPoint Technologies, Inc. In
November 2000, the Company changed its name to Kenexa Corporation, and
changed the name of TalentPoint Technologies, Inc. to Kenexa
Technology, Inc., or Kenexa Technology. Currently, Kenexa transacts
business primarily through Kenexa Technology. While the Company has several
product lines, our chief decision makers determine resource allocation decisions
and assess and evaluate periodic performance under one operating
segment.
   2.
Summary of Significant Accounting Policies
  In June
2009, the Financial Accounting Standards Board (“FASB”) issued Accounting
Standards Codification 2009-01, “Amendments based
on Statement of Financial Accounting Standards No. 168 - The FASB
Accounting Standards CodificationTM and the Hierarchy of Generally Accepted
Accounting Principles,” to codify in ASC 105, “Generally Accepted
Accounting Principles,” FASB Statement 168, “The FASB Accounting
Standards CodificationTM and the Hierarchy of Generally Accepted Accounting
Principles,” which was issued to establish the Codification as the sole
source of authoritative U.S. GAAP recognized by the FASB, excluding SEC
guidance, to be applied by nongovernmental entities. The guidance in ASC 105 is
effective for financial statements issued for interim and annual periods ending
after September 15, 2009. The Company has revised its references to
pre-Codification GAAP and noted no impact on the financial condition or results
of operations of the Company.
  The
accompanying consolidated financial statements as of March 31, 2010 and for the
three months ended March 31, 2010 and 2009 have been prepared by the Company
without audit.  In the opinion of management, all adjustments (which
include only normal recurring adjustments) necessary to present fairly the
financial position and the results of operations and cash flows for the three
months ended March 31, 2010 and 2009 have been made.  The results for
the three months ended March 31, 2010 are not necessarily indicative of the
results to be expected for the year ended December 31, 2010 or for any other
interim period.  Certain information and footnote disclosures normally
included in the Company’s annual consolidated financial statements have been
condensed or omitted and, accordingly, the accompanying financial information
should be read in conjunction with the consolidated financial statements and
notes thereto contained in the Company’s Annual Report on Form 10-K, filed with
the United States Securities and Exchange Commission for the year ended December
31, 2009.
   Principles
of Consolidation
  The
consolidated financial statements of the Company include the accounts of Kenexa
Corporation and its subsidiaries and Variable Interest Entity as described in
Footnote 5 – Variable Interest Entity in the Notes to Consolidated Financial
Statements.  All significant intercompany accounts and transactions
have been eliminated in consolidation.
  7
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Use
of Estimates
  The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates, and such
differences may be material to the Company’s consolidated financial
statements.
   Reclassifications
  Certain
reclassifications have been made to the prior period consolidated financial
statements to conform to the current period
presentation.  Reclassifications to the March 31, 2009 consolidated
cash flow statement include a transfer of $15 relating to accounts and unbilled
receivables to bad debt recoveries.
   Fair
Value of Financial Instruments
  The
carrying amounts of the Company’s financial assets and liabilities, including
cash and cash equivalents, accounts receivable, short-term investments, put
option and accounts payable at March 31, 2010 and December 31, 2009 approximate
fair value of these instruments.
   Concentration
of Credit Risk
  Financial
instruments which potentially expose the Company to concentration of credit risk
consist primarily of accounts receivable and the UBS Settlement Agreement.
Credit risk arising from receivables is mitigated due to the large number of
customers comprising the Company's customer base and their dispersion across
various industries.  The Company does not require
collateral.  The customers are concentrated primarily in the Company's
U.S. market area.  At March 31, 2010 and December 31, 2009, there were
no customers that represented more than 10% of the net accounts receivable
balance.  For the three months ended March 31, 2010 and 2009, there
were no customers that individually exceeded 10% of the Company's
revenues.
  As
discussed in Footnote 3 – Investments of the Notes to the Consolidated Financial
Statements, the Company has the right to sell its auction rate securities back
to UBS AG.  The ability of the Company to sell those securities is
dependent on the liquidity of UBS at the time of the sale.
   Cash
and Cash Equivalents
  Cash and
cash equivalents consist of highly liquid investments with remaining maturities
of three months or less at the time of purchase.  Cash which is
restricted for lease deposits is included in other assets.  Cash
balances are maintained at several banks. Accounts located in the United States
are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $100
(which has been temporarily increased to $250 through December 31, 2013).
Certain operating cash accounts may periodically exceed the FDIC
limits.
  Cash and
cash equivalents in foreign denominated currencies which are held in foreign
banks totaled $17,736 and $7,994 and represented 46.3% and 27.4% of our total
cash and cash equivalents balance at March 31, 2010 and December 31, 2009,
respectively.
  8
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Foreign
Currency Translation
  The
financial position and operating results of the Company’s foreign operations are
consolidated using the local currency as the functional currency. Local currency
assets and liabilities are translated at the rate of exchange to the U.S. dollar
on the balance sheet date, and the local currency revenues and expenses are
translated at average rates of exchange to the U.S. dollar during the period.
The operations of the variable interest entity in China are translated from
Chinese renminbis, which is approximately 6.8 renminbis to one U.S. dollar.
The related translation adjustments are reported in the shareholders' equity
section of the balance sheet and resulted in a net reduction in shareholders'
equity of $602 and $925 for the periods ended March 31, 2010 and December 31,
2009, respectively.  The foreign currency translation adjustment is
not adjusted for income taxes as it relates to an indefinite investment in a
non-U.S. subsidiary.
   Comprehensive
loss
  Comprehensive
loss consists of net gains and losses on foreign currency translations, net
unrealized gains and losses on available-for-sale investment securities, net
income allocated to noncontrolling interests and reported net income or loss
and is reported on the accompanying consolidated statement of shareholders'
equity.  Comprehensive loss as of March 31, 2010 and 2009 was $738 and
$36,669, respectively.
   Investments
  Investments
at March 31, 2010 and December 31, 2009 include floating rate letter of credit
backed securities, municipal bonds and auction rate securities.  The
maturities of these securities may range from 1 day to approximately 1 year and
are rated A, AA and AAA by various rating agencies.  Certain
investments are recorded at fair value based on current market rates and are
classified as available-for-sale.  Changes in the fair value are
included in accumulated other comprehensive loss in the accompanying
consolidated financial statements.  Other investments, which include
auction rate securities are recorded at fair value using a discounted cash flow
model and are classified as trading securities.  Changes in the fair
value are included in the statement of operations in the accompanying
consolidated financial statements.  Both the cost and realized gains
and losses of these securities are calculated using the specific identification
method.
   Investment
income
  Investment
income includes changes in the fair value of auction rate securities and put
option related to the UBS Settlement Agreement.  See Footnote 3 –
Investments of the Notes to Consolidated Financial Statements for further
details.
  9
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Software
Developed for Internal Use
  In accordance with FASB ASC 605, “Revenue
Recognition-Multiple Element Arrangements,” the Company applies FASB ASC
350, “Intangibles-Goodwill
and Other, Internal-Use Software.”  The costs incurred in the
preliminary stages of development are expensed as incurred. Once an application
has reached the development stage, internal and external costs, if direct and
incremental, are capitalized until the software is substantially complete and
ready for its intended use. Capitalization ceases upon completion of all
substantial testing. The Company also capitalizes costs related to specific
upgrades and enhancements when it is probable the expenditures will result in
additional functionality.  Maintenance and training costs are expensed
as incurred. Internal use software is amortized on a straight-line basis over
its estimated useful life, generally three years.  Management
evaluates the useful lives of these assets on an annual basis and tests for
impairments whenever events or changes in circumstances occur that could impact
the recoverability of these assets. There were no impairments to internal
software in any of the periods covered in these consolidated financial
statements.
  The
Company capitalized internal-use software costs for the three month period of
March 31, 2010 and the year ended December 31, 2009 of $2,658 and $9,665,
respectively. Amortization of capitalized internal-use software costs for the
three months ended March 31, 2010 and 2009 was $1,509 and $546,
respectively.
   Prepaid
Expenses and Other Current Assets
  Prepaid
expenses and other current assets as of March 31, 2010 and December 31, 2009 are
as follows:
  March
      31, 2010
                
                December
      31,
                  2009Prepaid
      expenses
                
                $
                5,833
                
                $
                4,845Deferred implementation costs
                
                
                2,407
                
                
                2,096UBS
      Settlement Agreement
                
                
                968
                
                
                1,374Other
      current assets
                
                
                636
                
                
                113Total
      current assets
                
                $
                9,844
                
                $
                8,428
   Deferred
implementation costs represent
internal payroll and other costs incurred in connection with the configuration
of the sites associated with our internet hosting
arrangements.   Prior to our adoption of ASU 2009-13 on January
1, 2010 (see revenue recognition accounting policy for implementation service
revenue), these costs were deferred over the implementation period which
precedes the hosting period, typically three to four months, and were expensed
ratably when the hosting period commences, typically four to five
years.  The remaining deferred costs at March 31, 2010 relate to
implementations which commenced prior to the adoption of ASU 2009-13 and will
continue to be deferred until such time as the hosting or license period for
those specific contracts commences, at which time these costs will be expensed
over the hosting period in accordance with our previous accounting
policy.  Implementation costs related to contracts signed or modified
after January 1, 2010, our date of adoption of ASU 2009-13, will be expensed as
incurred to be consistent with our new accounting policy related to
implementation service revenue.  During the three months ended March
31, 2010, approximately $481 of previously deferred costs were expensed as the
implementation revenue related to that contract is now being recognized in
accordance with our new revenue recognition policy as a material modification of
that contract also occurred during the quarter.
 Other
Long-Term Assets
  Other
long-term assets as of March 31, 2010 and December 31, 2009 are as
follows:
  March
      31, 2010
                
                December
      31,
                  2009Acquisition related escrow balances (1)
                
                $
                1,331
                
                $
                1,397Security
      deposits
                
                
                1,574
                
                
                1,529Deferred
      implementation costs
                
                
                6,140
                
                
                6,263Other
      long-term assets
                
                
                1,076
                
                
                214Total
      other long-term assets
                
                $
                10,121
                
                $
                9,403
  (1)
                Upon
      completion of the escrow term and settlement of any outstanding claims,
      all remaining escrow balances are reclassified to additional purchase
      price consideration for the respective
  acquisition.
   10
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
 Goodwill
  Since
2002, the Company has recorded goodwill in accordance with the provisions of
FASB ASC, 350, “Intangibles-Goodwill
and Other,” which discontinued the amortization of existing goodwill and
instead requires the Company to annually review the carrying value of goodwill
for impairment. Prior to 2007, the Company evaluated the carrying value of its
goodwill under two reporting units within its single segment.  During
2007, the Company combined those two reporting units into a single reporting
unit to be in alignment with its organizational and management structure which
was evaluated and restructured as part of the integration of our acquired
businesses.  As a result, in 2007 and 2008 goodwill was evaluated at
the enterprise or Company level.  Following its investment in the
variable interest entity in China in 2009, the Company reverted back to
evaluating the carrying value of goodwill under two reporting units within a
single segment.  The Company conducted its 2009 annual evaluation of
goodwill for impairment and determined that there was no impairment at October
1, 2009.  The Company determined there was no triggering event at
December 31, 2009 and March 31, 2010 which could require an interim impairment
analysis.
  The first
step of each analysis required the estimation of fair value of the Company and
was calculated primarily based on the observable market capitalization with a
range of estimated control premiums as well as discounted future estimated cash
flows. This step yielded an estimated fair value of the Company which was less
than the Company’s carrying value (including goodwill) at each test date,
December 31, 2008 and March 31, 2009. The next step entailed performing an
analysis to determine whether the carrying amount of goodwill on the Company’s
balance sheet exceeded its implied fair value. The implied fair value of the
Company’s goodwill for this step was determined in a similar manner as goodwill
recognized in a business combination. That is, the estimated fair value of the
Company was allocated to its assets and liabilities, including any unrecognized
identifiable intangible assets, as if the Company had been acquired in a
hypothetical business combination with the estimated fair value of the Company
representing the price paid to acquire it. The allocation process performed on
each test date was only for purposes of determining the implied fair value of
goodwill with no assets or liabilities written up or down, nor any additional
unrecognized identifiable intangible assets recorded as part of this process.
Based on these analyses, management recorded goodwill impairment charges of
$167,011 for the quarter and year ended December 31, 2008 and $33,329 for the
quarter ended March 31, 2009. The goodwill impairment charges had no effect on
the Company’s cash balances.
  The
changes in the carrying amount of goodwill, which include adjustments for
earnouts, taxes and escrow adjustments, acquisitions and impairment charges, for
the period ended March 31, 2010 and the year ended December 31, 2009 are as
follows:
  Balance
      as of December 31, 2008
                $
                32,366Acquisitions
      or adjustments:Impairment
      charge
                
                (33,329
                )StraightSource
                
                125HRC
      Human Resources Consulting GmbH
                
                215Quroum
      International Holdings Limited
                
                2,315Shanghai
      Runjie Management Consulting Company (variable interest
      equity)
                
                1,512Balance
      as of December 31, 2009
                $
                3,204HRC
      Human Resources Consulting GmbH
                
                (12
                )Quroum
      International Holdings Limited
                
                457Shanghai
      Runjie Management Consulting Company (variable interest
      equity)
                
                15Balance
      as of March 31, 2010
                $
                3,664
   Self-Insurance
  The
Company is self-insured for the majority of its health insurance costs,
including claims filed and claims incurred but not reported subject to certain
stop loss provisions. The Company estimated the liability based upon
management's judgment and historical experience. At March 31, 2010 and December
31, 2009, self-insurance accruals totaled $449 and $556,
respectively.  Management continuously reviews the adequacy of the
Company's stop loss insurance coverage. Material differences may result in the
amount and timing of health insurance expense if actual experience differs
significantly from management's estimates.
    11
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Revenue
Recognition
  The
Company derives its revenue from two sources: (1) subscription revenue for
solutions, which is comprised of subscription fees from customers accessing the
Company’s on-demand software, consulting services, outsourcing services and
proprietary content, and from customers purchasing additional support beyond the
standard support that is included in the basic subscription fee; and
(2) other fees for discrete professional services. Because the Company
provides its solutions as a service, the Company follows the provisions of FASB
ASC 605-10, “Revenue
Recognition” and FASB ASC 605-25 “Multiple Elements
Arrangements.”We recognize revenue when all of the following
conditions are met:
  •
                  
                  There
      is persuasive evidence of an arrangement;•
                  
                  The
      service has been provided to the customer;•
                  
                  The
      collection of the fees is probable; and•
                  
                  The
      amount of fees to be paid by the customer is fixed or
      determinable.
 Subscription
fees and support revenues are recognized on a monthly basis over the lives of
the contracts. Amounts that have been invoiced are recorded in accounts
receivable and in deferred revenue or revenue, depending on whether the revenue
recognition criteria have been met.
  Discrete
professional services and other revenues, when sold with subscription and
support offerings, are accounted for separately since these services have value
to the customer on a stand-alone basis and there is objective and reliable
evidence of fair value of the undelivered elements. The Company's arrangements
do not contain general rights of return.  Additionally, when
professional services are sold with other elements, the consideration from the
revenue arrangement is allocated among the separate elements based upon the
relative fair value.  Professional services and other revenues are
recorded as follows: Consulting revenues are recognized based upon proportional
performance as value is delivered to the customer.
  In
determining whether revenues from professional services can be accounted for
separately from subscription revenue, the Company considers the following
factors for each agreement: availability from other vendors, whether objective
and reliable evidence of fair value exists of the undelivered elements, the
nature and the timing of when the agreement was signed in comparison to the
subscription agreement start date and the contractual dependence of the
subscription service on the customer's satisfaction with the other services. If
the professional service does not qualify for separate accounting, the Company
recognizes the revenue ratably over the remaining term of the subscription
contract. In these situations the Company defers the direct and incremental
costs of the professional service over the same period as the revenue is
recognized.
  Deferred
revenue represents payments received or accounts receivable from the Company's
customers for amounts billed in advance of subscription services being
provided.
  The
Company records expenses billed to customers in accordance with FASB ASC
605-45,
“Revenue Recognition-Principal Agent Considerations,” which requires that
reimbursements received for out-of-pocket expenses be classified as revenues and
not as cost reductions.  These items primarily include travel, meals
and certain telecommunication costs. For the three months ended March 31, 2010
and 2009 reimbursed expenses totaled $473 and $530, respectively.
   12
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Revenue
Recognition (continued)
  Pursuant to the transition rules contained in Accounting
Standards Update 2009-13 (“ASU 2009-13”), “Multiple
Deliverable Revenue Arrangements,” the company elected to early adopt the
provisions included in the amendment effective January 1,
2010.
  Based
upon a review of its applicant tracking system (“ATS”) arrangements the Company
determined that implementation services, previously combined with hosting fees
as one unit of accounting, now qualify as a separate unit of
accounting.  This new approach is supported by existence of the
Company’s estimated selling prices for all of its deliverables within an ATS
arrangement and the assertion that the delivered items within these
arrangements, i.e. the implementation services, have standalone
value.  Under these arrangements, contract consideration will be
allocated to each deliverable using the relative selling price
method.  As a result of this adoption, implementation revenue
previously recognized over the license term, will be recognized in the period
the service is provided which corresponds to value delivered to the
customer.
  In
addition to modifying revenue recognition for ATS arrangements, the new guidance
contained in ASU 2009-13 permits the Company to unbundle multiple products
within an arrangement using the relative selling price
method.   Previously, these deliverables were treated as one unit
of accounting with revenue under these arrangements being deferred until all
products, for which the Company lacked objective evidence of fair value, were
delivered.  Under the new guidance, total consideration will be
allocated to each product based using the relative selling price method and
recognized as each product is delivered to the customer.  In addition,
the new guidance prohibits the use of the residual method for determining the
value of delivered element.
  Based
upon a preliminary analysis the Company has determined that the adoption of ASU
2009-13 will not have a material impact on the financial statements after the
initial adoption.  This conclusion is based in part on the following
facts:
 
   •
                Revenue
      that would have been recognized through March 31, 2010 if the related
      arrangements entered into or materially modified after the effective date
      were subject to the measurement requirements of FASB ASC 605-25, “Multiple
      Element Arrangements,” would have been $729 or 1.8% less than
      currently reported revenue of $39,664, for the three months ended March
      31, 2010.•
                Revenue that would have been recognized
      in the year before the year of adoption if the arrangements accounted for
      under ASC 605-25 were subject to the new measurement requirements of ASU
      2009-13 would have been $20 or less than .01% greater than the reported
      revenue of $38,831, for the three months ended March 31,
      2009.•
                Revenue recognized and deferred revenue as of and for the quarter
      ended March 31, 2010 from applying ASC 605-25 and ASU
      2009-13:
   Revenue
      recognized
                  
                  Deferred
      revenueASC
      605-25
                  
                  $
                  38,935
                  
                  $
                  51,307ASU
      2009-13
                  
                  
                  729
                  
                  
                  3,197Total
                  
                  $
                  39,664
                  
                  $
                  54,504
  13
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Revenue
Recognition (continued)
  The new revenue guidance contained in ASU 2009-13
modifies the way the Company accounts for its ATS arrangements, by allowing the
Company to separate its implementation services and corresponding license
fees into two separate units of accounting.  These two deliverables
represent the primary elements in an ATS arrangement and are recognized upon
performance or delivery of each service or product, respectively to the end
customer.  The implementation services are typically earned over a
three to six month period, while the license fees are recognized over a two to
five year period.  These arrangements usually do not contain
cancellation or refund-type provisions and may include termination for
convenience clauses following a stated period of time or performance level
commitments.
  Multiple element arrangements consisting of multiple
products are also impacted by the new revenue guidance.  Under ASU
2009-13 total consideration for an arrangement is allocated to each product
using the relative selling price method and revenue is recognized upon delivery
of the product or service.  Consistent with current practice, revenue
may be deferred if the arrangement includes any unusual terms including extended
payment terms, specified acceptance terms, or hold backs payable upon final
acceptance of the product.
  The Company utilizes a pricing model for its products which considers market
factors such as customer demand for its products, competitor’s pricing and the
geographic regions where the products are sold.   In addition,
the model considers entity-specific factors such as volume based pricing,
discounts for bundled products, total contract commitment and the number of
required languages for the product.  The pricing model for the
individual or bundled arrangement includes a price floor amount, which provides
for a 15% discount on the bundled price, and an actual quote to determine if the
quote is within an acceptable range for management’s
approval.  Including this final verification in the model ensures that
all of the Company’s selling prices are consistent and within an acceptable
range for use with the relative selling price method.
 
 While the pricing model, currently in use, captures all critical variables,
unforeseen changes due to external market forces may result in the Company
revising some of its inputs.  These modifications may result in the
consideration allocation differing from the one presently in
use.  Absent a significant change in the pricing inputs or the way in
which the industry structures its deals, future changes in the pricing model are
not expected to materially affect the Company’s allocation of arrangement
consideration.
    14
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Guarantees
  The
Company’s software license agreements typically provide for indemnifications of
customers for intellectual property infringement claims.  The Company
also warrants to customers, when requested, that the Company’s software products
operate substantially in accordance with standard specifications for a limited
period of time.  The Company has not incurred significant obligations
under customer indemnification or warranty provisions historically, and does not
expect to incur significant obligations in the future.  Accordingly,
the Company does not maintain accruals for potential customer indemnification or
warranty-related obligations.
   Earnings
(Loss) Per Share
  The
Company follows FASB ASC 260, “Earnings Per
Share,”which requires companies that are publicly held or have complex
capital structures to present basic and diluted earnings per share on the face
of the statement of operations.  Earnings (loss) per share is based on
the weighted average number of shares and common stock equivalents outstanding
during the period.  In the calculation of diluted earnings per share,
shares outstanding are adjusted to assume conversion of the exercise of options
if they are dilutive.  In the calculation of basic earnings per share,
weighted average numbers of shares outstanding are used as the
denominator.
 Common
stock equivalents of stock options issued and outstanding were excluded in the
computation of diluted earnings per share for the periods ended March 31, 2010
and 2009 since their effect was antidilutive.  A summary of the
computation is presented in the table below.
 
  Basic and diluted earnings (loss) per share are computed
as follows:
  Three
      months ended
                  March
      31,2010
                
                
                2009Numerator:Net
      loss allocable to common shareholders
                
                $
                (18
                )
                
                $
                (34,282
                )Denominator:Weighted
      average shares used to compute net loss allocable to common shareholders
      per common share - basic
                
                
                22,577,266
                
                
                
                22,509,304Effect
      of dilutive stock options
                
                
                —
                
                
                
                —Weighted
      average shares used to compute net loss allocable to common shareholders
      per common share – dilutive
                
                
                22,577,266
                
                
                
                22,509,304Basic
      net loss per share
                
                $
                0.00
                
                
                $
                (1.52
                )Diluted
      net loss per share
                
                $
                0.00
                
                
                $
                (1.52
                )Total
      antidilutive stock options issued and outstanding
                
                
                2,297,956
                
                
                
                2,932,056
    15
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Share-based
Compensation Expense
  On
January 1, 2006, the Company adopted FASB ASC 718, “Compensation-Stock
Compensation,” using the Modified Prospective Approach (“MPA”). The MPA
requires that compensation expense be recorded for restricted stock and all
unvested stock options as of January 1, 2006.  Following the
adoption the Company recognized the cost of previously granted share-based
awards under the straight-line basis over the remaining vesting
period.  The compensation expense for new share-based awards with a
service condition that cliff vest, is recognized on a straight-line basis over
the award’s requisite service period.  For those awards with a service
condition that have graded vesting, compensation expense is calculated using the
graded-vesting attribution method.   This method entails
recognizing expense on a straight-line basis over the requisite service period
for each separately vesting portion as if the grant consisted of multiple
awards, each with the same service inception date but different requisite
service periods.  This method accelerates the recognition of
compensation expense.  In accordance with FASB ASC 18, the pool of
excess tax benefits available to absorb tax deficiencies was determined using
the alternative transition method.
  The fair
value of market based, performance vesting share awards granted is calculated
using a Monte Carlo valuation model that results in a factor applied to the fair
market value of the Company's common stock on the date of the grant (measurement
date), and is recognized over a four year explicit service period using the
straight-line method.  Since the award requires both the completion of
four years of service and the share price reaching predetermined levels as
defined in the option agreement, compensation cost will be recognized over the
four year explicit service period.  If the employee terminates prior
to the four-year requisite service period, compensation cost will be reversed
even if the market condition has been satisfied by that time.
   Adoption
of new accounting pronouncements
  In June
2009, the FASB issued new accounting guidance for variable interest entities.
This guidance was codified under ASU 2009-17 in December 2009 and includes: (1)
the elimination of the exemption from consolidation for qualifying special
purpose entities, (2) a new approach for determining the primary beneficiary of
a variable interest entity (“VIE”), which requires that the primary beneficiary
have both (i) the power to control the most significant activities of the VIE
and (ii) either the obligation to absorb losses or the right to receive benefits
that could potentially be significant to the VIE, and (3) the requirement to
continually reassess who should consolidate a VIE. The new guidance is effective
for annual reporting periods that begin after November 15, 2009 and applies to
all existing and new VIEs. The Company adopted ASU 2009-17 in 2010 and the
adoption did not have a material impact on the Company's financial
statements.
 Effective
October 2009, we adopted the Accounting Standards Update (“ASU”)
No. 2009-13, “Revenue
Recognition: Multiple-Deliverable Revenue Arrangements - a consensus of the FASB
Emerging Issues Task Force,” which eliminates the use of the residual
method for allocating consideration, as well as the criteria that requires
objective and reliable evidence of fair value of undelivered elements in order
to separate the elements in amultiple-element
arrangement. By removing the criterion requiring the use of objective and
reliable evidence of fair value in separately accounting for deliverables, the
recognition of revenue will more closely align with certain revenue
arrangements. The standard also will replace the term "fair value" in the
revenue allocation guidance with "selling price" to clarify that the allocation
of revenue is based on entity-specific assumptions rather than assumptions of a
marketplace participant. ASU No. 2009-13 is effective for revenue
arrangements entered or materially modified in fiscal years beginning on or
after June 15, 2010.
 
 Effective
July 1, 2009, we adopted “The FASB Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting
Principles.” This standard establishes only two levels of GAAP,
authoritative and non-authoritative. The FASB Accounting Standards Codification
(the “Codification”) became the source of authoritative, non-governmental GAAP,
except for rules and interpretive releases of the SEC, which are sources of
authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC
accounting literature not included in the Codification became non-authoritative.
We began using the new guidelines and numbering system prescribed by the
Codification when referring to GAAP in the third quarter of fiscal 2009. As the
Codification was not intended to change or alter existing GAAP, it did not have
any impact on our consolidated financial statements.
    16
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   2.
Summary of Significant Accounting Policies (continued)
  Adoption
of new accounting pronouncements (continued)
  In
May 2009, the FASB adopted Codification Topic 855, “Subsequent
Events,” which codifies the guidance regarding the disclosure of events
subsequent to the balance sheet date. The statement established general
standards of accounting for and disclosure of events that occur after the
balance sheet date but before financial statements are issued or are available
to be issued. ASC 855 is effective for interim or annual financial periods
ending after June 15, 2009, and shall be applied prospectively. The adoption ASC
855 did not have a material impact on the Company’s financial
statements.


In April
2009, the FASB amended ASC 805 “Business
Combinations,” which established a model to account for certain
pre-acquisition contingencies. Under ASC 805, an acquirer is required to
recognize at fair value an asset acquired or a liability assumed in a business
combination that arises from a contingency if the acquisition-date fair value of
that asset or liability can be determined during the measurement period. If the
acquisition-date fair value cannot be determined, then the acquirer should
follow the recognition criteria in ASC 450, “Contingencies”. In the first
quarter of 2009, we adopted ASC 805 and will apply its provisions when
applicable.
  In December 2007, the FASB issued ASC 810-10, “Consolidation-Overall,”
and ASC 805, “Business
Combinations.”  Changes for business combination transactions
pursuant to ASC 805 include, among others, expensing of acquisition-related
transaction costs as incurred, the recognition of contingent consideration
arrangements at their acquisition date fair value and capitalization of
in-process research and development assets acquired at their acquisition date
fair value. Changes in accounting for noncontrolling (minority) interests
pursuant to ASC 810-10 include, among others, the classification of
noncontrolling interest as a component of consolidated shareholders' equity and
the elimination of "minority interest" accounting in results of operations. ASC
805 is required to be adopted and was effective for fiscal years beginning on or
after December 15, 2008. The adoption of ASC 805 and ASC 810-10 impacted the
Company’s accounting related to the consolidation of its variable interest
entity in 2009 and will impact the accounting for the Company's future
acquisitions.
   New
Accounting Pronouncements
 
 In March
2010 the EITF Task Force reached a consensus on EITF Issue No. 08-9, “Milestone Method
of Revenue Recognition,” which permits the use of the milestone method as
a valid application of the proportional performance model for revenue
recognition if the milestones are substantive and there is substantive
uncertainty about whether the milestones will be achieved.  In order
to meet the definition of substantive, the milestone would have to 1) be
commensurate  with either the level of effort required to achieve the
milestone or the enhancement in the value of the item delivered, 2) have to
relate solely to past performance, and 3) should be reasonable relative to all
deliverables and payment terms in the arrangement.  If ratified by the
FASB, the new guidance would be effective for interim and annual periods
beginning on or after June 15, 2010 with early adoption
permitted.  The Company is currently evaluating the impact of adopting
this new guidance.
 
   
 17
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
  3.  Investments
 
 The
following is a summary of our short-term investments at March 31, 2010 and
December 31, 2009:
  As of
March 31, 2010:
  Cost
              
              
              Unrealized
      gain (loss)
              
              
              Accrued
      interest
              
              
              Fair
      market valueAvailable
      for Sale securitiesMunicipal
      securities
              
              $
              14,130
              
              
              $
              (118
              )
              
              $
              —
              
              
              $
              14,012Trading
      SecuritiesAuction
      rate securities
              
              
              9,864
              
              
              
              376
              
              
              
              —
              
              
              
              10,240Total
      short-term investments
              
              $
              23,994
              
              
              $
              258
              
              
              $
              —
              
              
              $
              24,252
   As of
December 31, 2009:
  Cost
              
              
              Unrealized
      gain (loss)
              
              
              Accrued
      interest
              
              
              Fair
      market valueAvailable
      for Sale securitiesMunicipal
      securities
              
              $
              15,627
              
              
              $
              (89
              )
              
              $
              118
              
              
              $
              15,656Trading
      SecuritiesAuction
      rate securities
              
              
              13,737
              
              
              
              177
              
              
              
              —
              
              
              
              13,914Total
      short-term investments
              
              $
              29,364
              
              
              $
              88
              
              
              $
              118
              
              
              $
              29,570
   Unrealized
gains and losses from fixed-income, available for sale securities are primarily
attributable to changes in interest rates.  The Company does not
believe any unrealized losses represent an other-than-temporary impairment based
on the evaluation of available evidence as of March 31, 2010.  For the
periods ended March 31, 2010 and December 31, 2009, contractual maturities of
our short-term investments were one year or less.
  
 18
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
  3.  Investments
(continued)
  During
the three months ended March 31, 2010, the Company redeemed two tax exempt
auction rate securities (“ARS”), partially redeemed three ARS and continued to
experience failed auctions for the remaining seven ARS issues with a fair value
of $10,239.  Seven of these ARS are guaranteed by the Family Federal
Educational Loan Program with the remainder being insured by private
issuers.  Due to the ability to liquidate the ARS issues within the
next twelve months and the put option, the Company included these investments in
its short-term investments as of March 31, 2010.  These securities
will continue to accrue interest at the contractual rate and will be auctioned
every 90 days until sold.
  Due to the failure of the auction rate market in early 2008, UBS AG and other
major banks entered into discussions with government agencies to provide
liquidity to owners of auction rate securities. In November 2008, the Company
entered into an agreement (the “UBS Settlement Agreement”) with UBS AG which
provided (1) the Company with a “no net cost” loan up to the par value of
Eligible ARS until June 30, 2010, and  (2) the Company, the right
to sell these auction rate securities back to UBS AG at par, at the Company’s
sole discretion, anytime during the period from June 30, 2010 through
July 2, 2012, and (3) UBS AG the right to purchase these auction rate
securities or sell them on the Company’s behalf at par anytime through
July 2, 2012.  Following the execution of the UBS Settlement
Agreement, the Company determined that it no longer had the intent to hold the
ARS until either the maturity or recovery of the ARS market. Based upon this
unusual circumstance related to the execution of the UBS Settlement Agreement,
the Company transferred these investments from available-for-sale to trading
securities and began recording the change in fair value of the ARS as gains or
losses in current statement of operations.  As of March 31, 2010, the
auction rate securities, which were acquired through UBS AG, had a par value of
$11,250.
  Contemporaneous with the determination to transfer the ARS to trading
securities, the Company elected to measure the value of its option to put the
securities (“put option”) to UBS AG under the fair value option of ASC 825,
“Financial
Instruments”.  As a result, the Company recorded at December
31, 2008 a non-operating gain representing the estimated fair value of the put
option and a corresponding long-term asset of approximately
$2,219.  At December 31, 2009 the put option’s estimated fair value
decreased to $1,374.  At March 31, 2010, the put option’s estimated
fair value decreased to $968, resulting in a non-operating loss of $407 for the
three months ended March 31, 2010.  The estimated fair value of the
put option as of March 31, 2010 was based in part on an expected life of three
months and a discount rate of 0.75%.  In June 2009, due to our ability
to exercise our put option within the next twelve months, we reclassified the
estimated fair value of the put option to other current assets on the
consolidated balance sheet.
  Based upon the results of the discounted cash flow analysis, the Company
determined that the fair value of its investment in ARS should be discounted
approximately $2,219 to $16,513 at December 31, 2008, with any other-than
temporary impairment in the fair value of the ARS  offset
substantially by the fair value recognized for the rights provided in the
settlement agreement.  As a result of the transfer of the ARS from
available-for-sale to trading investment securities noted above, the Company
also recorded a non-operating gain for the twelve months ended December 31, 2009
of approximately $833. The recording of the loss relating to the decrease in the
fair value of the put option of $407 and the recognition of the gain in the ARS
of $376 resulted in an overall net loss of approximately $31 for the three
months ended March 31, 2010.
  The Company adjusted the fair value of its ARS investment portfolio using a
discounted cash flow model to determine the estimated fair value of its ARS
investments as of March 31, 2010.  The ranges of assumptions used in
preparing the discounted cash flow model include level three inputs, as defined
in ASC 825, and are presented in the following table:
  Minimum
              
              
              MaximumMaximum
      auction rate (interest rate)
              
              
              0.5
              %
              
              
              2.1
              %Liquidity
      risk premium
              
              
              4.0
              %
              
              
              5.0
              %Probability
      of earned maximum rate until maturity
              
              
              0.01
              %
              
              
              0.2
              %Probability
      of default
              
              
              1.4
              %
              
              
              20.41
              %
   19
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   3.  Investments (continued)
  The
Company has investments that are valued in accordance with the provisions of ASC
820, “Fair
Value Measurements and Disclosure”. Under this standard, fair value is
defined as the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the
measurement date.  ASC 820, Fair Value Measurements and Disclosure
establishes a hierarchy for inputs used in measuring fair value that maximizes
the use of observable inputs and minimizes the use of unobservable inputs by
requiring that the most observable inputs be used when available. The hierarchy
is broken down into three levels based on the reliability of inputs as
follows:
 
   •
              Level 1 - Valuations based on quoted prices in active markets for
      identical assets that the Company has the ability to
      access.•
              Level 2 - Valuations based inputs on other than quoted prices
      included within level 1, for which all significant inputs are observable,
      either directly or indirectly.•
              Level
      3 - Valuations based on inputs that are unobservable and significant to
      the overall fair value measurement.
   The
estimated fair value of the Company’s municipal investments on March 31, 2010
and December 31, 2009 of $14,012 and $15,656, respectively, was determined based
upon quoted prices in active markets for identical assets or Level 1
inputs.  The estimated fair value of the Company’s auction rate
securities on March 31, 2010 and December 31, 2009 of $10,240 and $13,914,
respectively, was determined based upon significant unobservable inputs or Level
3 inputs.
  A
reconciliation of the beginning and ending balances for the auction rate
securities using significant unobservable inputs (Level 3) for the period ended
March 31, 2009 is presented below:
  Auction
      rate securitiesBalance
      at December 31, 2008
              
              $
              16,513Net
      realized gains included in earnings
              
              
              267Settlements
              
              
              (1,307
              )Balance
      at March 31, 2009
              
              $
              15,473
  A
reconciliation of the beginning and ending balances for the auction rate
securities using significant unobservable inputs (Level 3) for the period ended
March 31, 2010 is presented below:
  Auction
      rate securitiesBalance
      at December 31, 2009
              
              $
              13,914Net
      realized losses included in earnings
              
              
              376Settlements
              
              
              (4,050
              )Balance
      at March 31, 2010
              
              $
              10,240
  Based on
the size of this investment, the Company’s ability to access cash and other
short-term investments, and expected operating cash flows, the Company does not
anticipate the illiquidity of this investment will affect its
operations
  
 20
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
  4.
Acquisitions
  Quorum
International Holdings Limited
  On April
2, 2008, the Company acquired all of the outstanding stock of Quorum
International Holdings Limited (“Quorum”), a provider of recruitment process
outsourcing services based in London, England, for a purchase price of
approximately $27,950, in cash, of which $19,753 was paid in April 2008 and
$8,197 was paid in July 2008.  The total cost of the acquisition,
including legal, accounting, other professional fees and additional
consideration of $2,873, was approximately $30,823, including acquired
intangibles of $8,633, with estimated useful lives between 3 and 10
years.  In addition, the acquisition agreement contains an earnout
provision which provides for the payment of additional consideration by the
Company based upon the gross profit of Quorum for the twelve month period ending
June 30, 2009 and June 30, 2010.  Formulaically, the earnout is 3.86 times
Quorum’s gross profit less the amount of base consideration, as defined in the
agreement.  Pursuant to FASB ASC 805, “Business
Combinations,” the Company accrues contingent purchase consideration when
the outcome of the contingency is determinable beyond a reasonable
doubt.  Based upon the results for the twelve month period through
June 30, 2009, it was determined that an earnout payment was due to the former
shareholders of Quorum and as such, the additional consideration of $1,167 was
accrued for in the financial statements at December 31, 2009.  During
the first quarter of 2010 additional consideration of $468 was determined
payable.  The total consideration of $1,635 was paid in cash during
the first quarter of 2010.  In addition, as of March 31, 2010, the
June 30, 2010 earnout amount was substantially uncertain, and, as such, the
estimated earnout range is not possible to disclose.  The Company
evaluates the earnout provisions contained in the acquisition agreement at each
financial statement reporting date.  In connection with the acquisition,
€500 or approximately $675, of the purchase price was deposited into an escrow
account and recorded
in other long-term assets, to cover any claims for indemnification made by the
Company against Quorum under the acquisition agreement.  The escrow
agreement will remain in place for approximately two years from the acquisition
date, and any funds remaining in the escrow account at the end of the two year
period will be distributed to the former stockholders of
Quorum.  The
Company is currently evaluating that status of any claims and the amounts to be
withheld from the escrow account.The Company expects that the
acquisition of Quorum will broaden its presence in the global recruitment
market.  The purchase price has been allocated to the assets
acquired and liabilities assumed based upon management’s best estimate of
fair value with any excess over the net tangible and intangible assets acquired
allocated to goodwill.   Quorum’s results of operations were included
in the Company’s consolidated financial statements beginning on April 2,
2008.
   
 21
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   5.
Variable Interest Entity
  On
January 20, 2009, the Company entered into an ownership interest transfer
agreement (“the agreement”) with Shanghai Runjie Management Consulting Company,
(“R and J”) in Shanghai, China.   In conjunction with the
agreement, the Company paid $1,337 to provide an initial equity contribution and
to compensate the former owners of R and J, who transferred their existing
business into a new entity, Shanghai Kenexa Human Resources Consulting Co.,
Ltd., (the “variable interest entity”).   The initial payment
provided the Company with a 46% ownership in the variable interest entity, and a
presence in China’s human capital management market.   The former
owners of R and J are required to transfer 1% additional ownership interests (in
1% increments up to 49% over a two year period), with consideration to be paid
by the Company based upon adjusted EBITDA, as defined in the
agreement.  In the fourth quarter of 2009, based upon the 2008
operating results for R and J, the Company paid an additional $206 for an
additional 1% ownership interest in the variable interest
entity.   At December 31, 2009 and March 31, 2010, the Company
had a 47% ownership interest in the variable interest entity.
  Consideration
for the ownership interest transfer  in the third quarter was
determined as the greater of 1) the amount of registered capital attributable to
a 1% ownership interest or 2) an amount denominated in Chinese Yuan Renminbi
(“RMB¥”) equal to the result of 47% times four and one half times the Adjusted
EBITDA of the variable interest entity for the calendar year ended December 31,
2008, plus 1% of the variable interest entity’s free cash flow as of March 31,
2008, minus the amount of the initial investment or RMB¥ 8,145 or $1,224. The
additional transfers of ownership interests for 2010 and 2011 will be determined
formulaically the same as above and will be adjusted only for any increase in
actual ownership percentage by the Company.
  Under the
terms of the variable interest entity agreement, the Company has the right to
acquire R and J’s remaining interest in the variable interest entity at any time
after the earlier of the termination of the general manager’s employment by the
variable interest entity or during the first three months of any calendar year
beginning on or after January 1, 2013 (call rights).  The purchase
price for the remaining ownership interest is based upon the outstanding
ownership interest multiplied by the sum of the amount of free cash flow plus
four and one half times the Adjusted EBITDA, as defined in the agreement. R and
J may also require the Company to purchase its interest in the variable interest
entity at any time after the earlier of the Company’s acquisition of more than
fifty percent of the variable interest entity or January 1, 2011 (put
rights).
  In
accordance with ASC 810, “Variable Interest
Entities,” the new entity qualified for consolidation as it was
determined to be a variable interest entity and the Company as its primary
beneficiary.   The determination of the primary beneficiary was
based, in part, upon a qualitative assessment which included the Company’s
commitment to finance the variable interest entity’s ongoing operations, the
level of involvement in the variable interest entity’s operations, the use of
the Company’s brand by the variable interest entity, and the lack of equity “at
risk” by R and J given its put rights.  The variable interest entity
is consolidated in the Company’s financial statements because of the Company’s
implicit guarantee to provide financing and as well as its significant
involvement in the day-to-day operations.   The equity interests
of R and J not owned by the Company are reported as a noncontrolling interest in
the Company’s December 31, 2009 and March 31, 2010 accompanying consolidated
balance sheet.  All inter-company transactions are
eliminated.  See Footnote 2 – Summary of Significant Accounting
Policies Principles of Consolidation for additional details.
  The
variable interest entity was financed with $307 in initial equity contributions
from the Company and R and J, and has no borrowings for which its assets would
be used as collateral.  Following the formation of the variable
interest entity, the Company completed a valuation of the concern, which
resulted in the recording of net tangible assets, intangible assets and goodwill
of $314, $1,100 and $1,512, respectively in the consolidated balance
sheet.   On September 30, 2009, the Company provided $160 of
financing for the variable interest entity in the form of an intercompany
loan.   The creditors of the variable interest entity do not have
recourse to other assets of the Company.
  Pursuant
to ASC 480 “Distinguishing
Liabilities from Equity” (formerly Emerging Issues Task Force Abstracts
Topic No. D-98, “Classification and
Measurement of Redeemable Securities,”due to the put rights included in
the agreement, the Company has presented the estimated fair value of R and J’s
53% ownership interest in the variable interest entity amounting to $1,393 at
March 31 31,2010 in noncontrolling interest and classified the amount as
mezzanine equity (temporary equity) on the consolidated balance
sheet.
 
 22
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements – Unaudited (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   6.
Property, Equipment and Software
  A summary
of property, equipment and software and related accumulated depreciation and
amortization as of March 31, 2010 and December 31, 2009 is as
follows:
  March
      31,
                  2010
                
                December
      31, 2009Equipment
                
                $
                18,129
                
                $
                17,748Software
                
                
                30,227
                
                
                28,397Office
      furniture and fixtures
                
                
                2,436
                
                
                2,455Leasehold
      improvements
                
                
                2,764
                
                
                2,735Land
                
                
                741
                
                
                714Building
                
                
                8,162
                
                
                7,828Software
      in development
                
                
                4,240
                
                
                3,083Total
      property, equipment and software
                
                
                66,699
                
                
                62,960Less
      accumulated depreciation and amortization
                
                
                29,089
                
                
                26,093Total
      property, equipment and software, net of accumulated depreciation and
      amortization
                
                $
                37,610
                
                $
                36,867
 Depreciation
and amortization expense is excluded from cost of revenues.  Equipment
and office furniture and fixtures included assets under capital leases totaling
$2,608 and $2,621 at March 31, 2010 and December 31, 2009, respectively.
Depreciation and amortization expense, including amortization of assets under
capital leases, was $3,115 and $2,145 for the three months ended March 31, 2010
and 2009, respectively.
  Pursuant
to FASB ASC 360, “Property, Plant
and Equipment,” the Company reviewed its fixed assets and determined that
the fair value exceeded the carrying value, and therefore did not record any
fixed asset impairment as of March 31, 2010.
   7.
Other Accrued Liabilities
  Other accrued liabilities consist of the following:
  March
      31,
                2010
              
              December
      31, 2009Accrued
      professional fees
              
              $
              910
              
              $
              1,031Straight
      line rent accrual
              
              
              1,987
              
              
              2,084Other
      taxes payable
              
              
              219
              
              
              118Income
      taxes payable
              
              
              1,903
              
              
              837Other
      liabilities
              
              
              1,173
              
              
              1,139Contingent
      purchase price
              
              
              —
              
              
              1,167Total
      other accrued liabilities
              
              $
              6,192
              
              $
              6,376
  
  
 23
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   8.
Line of Credit
  On May
21, 2009, based upon its current liquidity needs, the Company elected not to
renew its secured credit agreement with PNC Bank, as administrative agent, and
several other lenders named therein (the “Credit Agreement”). The Credit
Agreement, which became effective November 13, 2006, provided (i) a $50 million
revolving credit facility, including a sublimit of up to $2 million for letters
of credit and (ii) a $50 million term loan.  The Company and each of
its U.S. subsidiaries guaranteed the obligations of the Company under the Credit
Agreement.  The Credit Agreement also required the Company to pay a
monthly commitment fee based on the unused portion of the revolving credit
facility.  At May 21, 2009, the Company had no outstanding balance on
the Credit Agreement. Unless renewed, the Credit Agreement would have expired on
its own terms on March 26, 2010.  No early termination penalties were
incurred in connection with the termination of the Credit
Agreement.  In connection with the termination of the Credit
Agreement, the Company wrote off $289 of deferred financing fees during the
quarter ended June 30, 2009.  As a result of the termination of the
Credit Agreement, the Company does not have a revolving credit facility or other
debt financing arrangement.
   9.  Income
Taxes
  The
Company’s tax provision for interim periods is determined using an estimate of
its annual effective tax rate.  The 2010 effective tax rate is
estimated to be lower than the 35% statutory U.S. Federal rate primarily due to
anticipated earnings in subsidiaries outside the U.S. in jurisdictions where the
effective rate is lower than in the U.S. and tax exempt interest
income.
  On
January 1, 2007, we adopted the FASB ASC 740, “Income Taxes,” which clarifies the accounting
for uncertain income tax positions recognized in financial statements and
requires the impact of a tax position to be recognized in the financial
statements if that position is more likely than not of being sustained by the
taxing authority.  The Company does not expect that the amount of
unrecognized tax benefits will significantly increase or decrease within the
next twelve months.  Our policy is to recognize interest and penalties on
unrecognized tax benefits in the provision for income taxes in the consolidated
statements of operations.  Tax years beginning in 2005 are subject to
examination by taxing authorities, although net operating loss and credit
carryforwards from all years are subject to examinations and adjustments for at
least three years following the year in which the attributes are
used.
  During
the three months ended March 31, 2010, the valuation allowance increased by $115
from $7,460 at December 31, 2009 to $7,575 as management continues to
believe based on the weight of available evidence, it is more likely than
not that some or all of the deferred tax asset will not be
realized.
 
 24
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   10.
Commitments and Contingencies
  Litigation
  On August
27, 2007, a complaint was filed and served by Kenexa BrassRing, Inc. against
Taleo Corporation in the United States District Court for the District of
Delaware.  Kenexa alleges that Taleo infringed Patent Nos. 5,999,939
and 6,996,561, and seeks monetary damages and an order enjoining Taleo from
further infringement.
  On May 9,
2008, Kenexa BrassRing, Inc. filed a similar lawsuit against Vurv Technology,
Inc. in the United States District Court for the District of Delaware, alleging
that Vurv has infringed Patent Nos. 5,999,939 and 6,996,561, and seeks monetary
damages and an order enjoining further infringement.  This lawsuit has been
consolidated with the Kenexa BrassRing, Inc. versus Taleo Corporation
lawsuit.
  On June
25, 2008, Kenexa Technology, Inc. filed suit in the United States District Court
of Delaware against Taleo Corporation for tortious interference with contract,
unfair competition, unfair trade practices and unjust enrichment. On August 28,
2009, Taleo filed an amended answer and counterclaim against Kenexa BrassRing,
Inc. asserting copyright infringement against Kenexa by the users accessing the
Taleo system on behalf of Kenexa’s recruitment process outsourcing customers.
Kenexa seeks monetary damages and to enjoin the actions of
Taleo.  Taleo seeks monetary damages and to enjoin the actions of
Kenexa.
  On
November 7, 2008, Vurv Technology LLC, sued Kenexa Corporation, Kenexa
Technology, Inc., and two former employees of Vurv, who now work for Kenexa , in
the United States District Court for the Northern District of
Georgia.  In this action, Vurv asserts claims for breach of contract,
computer trespass and theft, misappropriation of trade secrets, interference
with contract and civil conspiracy.   Vurv seeks unspecified monetary
damages and injunctive relief.
  On June
11, 2009 and July 16, 2009, two putative class actions were filed against Kenexa
Corporation and our Chief Executive Officer and Chief Financial Officer in the
United States District Court for the Eastern District of Pennsylvania,
purportedly on behalf of a class of our investors who purchased our publicly
traded securities between May 8, 2007 and November 7, 2007. The complaint filed
on July 16, 2009 has since been voluntarily dismissed.  In the pending
action, Building Trades United Pension Trust Fund, individually and on behalf of
all others similarly situated alleges violations of Section 10(b) of the
Securities Exchange Act of 1934 ("Exchange Act"), Rule 10b-5 promulgated
thereunder and Section 20(a) of the Exchange Act in connection with various
public statements made by Kenexa.  This action seeks unspecified damages,
attorneys’ fees and expenses.
  On July
17, 2009, Kenexa BrassRing, Inc. and Kenexa Recruiter, Inc. filed suit
against Taleo Corporation, a current Taleo employee and a former Taleo
employee in Massachusetts Superior Court.  Kenexa amended the
complaint on August 27, 2009 and added Vurv Technology LLC, two former employees
of Taleo and two current employees of Taleo.  Kenexa asserts claims
for breach of contract and the implied covenant of good faith and fair dealing,
unfair trade practices, computer theft, misappropriation of trade secrets,
tortious interference, unfair competition, and unjust
enrichment.  Kenexa seeks monetary damages and injunctive
relief.
  The
Company is involved in claims, including those identified above, which arise in
the ordinary course of business. In the opinion of management, the Company has
made adequate provision for potential liabilities, if any, arising from any such
matters.  However, litigation is inherently unpredictable, and the
costs and other effects of pending or future litigation, governmental
investigations, legal and administrative cases and proceedings (whether civil or
criminal), settlements, judgments and investigations, claims and changes in any
such matters, could have a material adverse effect on the Company’s business,
financial condition and operating results.
   
 25
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   11.
Equity
  Rollforward
of Shares
  The
Company’s common shares issued for the three months ended March 31, 2010 and the
year ended December 31, 2009 are as follows:
  Class
      A
                Common
      SharesDecember
      31, 2008 ending balance
              
              
              22,504,924Stock
      option exercises
              
              
              14,747Employee
      stock purchase plan
              
              
              42,212December
      31, 2009 ending balance
              
              
              22,561,883Stock
      option exercises
              
              
              21,851Employee
      stock purchase plan
              
              
              10,188March
      31, 2010 ending balance
              
              
              22,593,922
  Refer to
the accompanying consolidated statements of shareholders' equity and this note
for further discussion.
   Stock
and Voting Rights
  Undesignated
Preferred Stock
  The
Company has 10,000,000 shares of $0.01 par value undesignated preferred stock
authorized, with no shares issued or outstanding at March 31, 2010 or
December 31, 2009. These shares have preferential rights in the event of
liquidation and payment of dividends.
   Common
Stock
  At March
31, 2010 and December 31, 2009, the Company had 100,000,000 authorized
shares of common stock.  At March 31, 2010 and December 31, 2009,
shares of common stock outstanding were 22,593,922 and 22,561,883,
respectively.  Each share of common stock has one-for-one voting
rights.
   Authorized
but not issued shares
  On
February 20, 2008, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 3,000,000 shares of the Company’s common
stock, of which 1,125,651 shares were repurchased at an aggregate cost of
$20,429 as of December 31, 2008.  These shares were restored to
original status prior to December 31, 2008 and accordingly are presented as
authorized but not issued.  The timing, price and volume of
repurchases were based on market conditions, relevant securities laws and other
factors.  As of December 31, 2008 the amount of shares available for
repurchase under the stock repurchase plan was 1,874,349.  No
repurchases were or have been made under the stock repurchase plan from January
1, 2009 to March 31, 2010.
 
 26
 Table of Contents
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   12.
Stock Plans
  Equity
Incentive Plan
  The
Company’s 2005 Equity Incentive Plan (the “2005 Option Plan”), which was adopted
by the Company’s Board of Directors (the “Board”) in March 2005 and was approved
by the Company’s shareholders in June 2005, provides for the granting of stock
options, restricted stock and restricted stock units to employees and directors
at the discretion of the Board or a committee of the Board.  The 2005
Option Plan replaced the Company’s 2000 Stock Option Plan (the “2000 Option
Plan”).  The purpose of stock options is to recognize past services
rendered and to provide additional incentive in furthering the continued success
of the Company.  Stock options granted under both the 2005 Option Plan
and the 2000 Stock Option Plan expire between the fifth and tenth anniversary of
the date of grant and generally vest on the third anniversary of the date of
grant.  Unexercised stock options may expire up to 90 days after
an employee's termination for options granted under the 2000 Option
Plan.
  As of
March 31, 2010, there were options and restricted stock to purchase 3,590,356
and 85,000, respectively, shares of common stock outstanding under the 2005
Option Plan.  The Company is authorized to issue up to an aggregate of
4,842,910 shares of its common stock pursuant to stock options and restricted
stock granted under the 2005 Option Plan.  As of March 31, 2010, there
were a total of 508,206 shares of common stock not subject to outstanding
options and restricted stock and available for issuance under the 2005 Option
Plan.
  FASB ASC
718, “Compensation-Stock
Compensation”, requires companies to estimate the fair value of
share-based payment awards on the date of grant using an option-pricing
model.  In 2010 and 2009, the fair value of each grant was estimated
using the Black-Scholes valuation model.  Expected volatility was
based upon a weighted average of peer companies and the Company’s stock
volatility.  The expected life was determined based upon an average of
the contractual life and vesting period of the options.  The estimated
forfeiture rate was based upon an analysis of historical
data.   The risk-free rate was based on U.S. Treasury zero coupon
bond yields for periods commensurate with the expected term at the time of
grant.
  Compensation
expense, for awards with a service condition that cliff vest, is recognized on a
straight-line basis over the award’s requisite service
period.   For those awards with a service condition that have a
graded vest, compensation expense is calculated using the graded-vesting
attribution method.   This method entails recognizing expense on
a straight-line basis over the requisite service period for each separately
vesting portion as if the grant consisted of multiple awards, each with the same
service inception date but different requisite service periods.  This
method accelerates the recognition of compensation expense.
  The fair
value of market based, performance vesting share awards granted is calculated
using a Monte Carlo valuation model that simulates various potential outcomes of
the option grant and values each outcome using the Black-Scholes valuation model
which yields a fair market value of the Company's common stock on the date of
the grant (measurement date).  This amount is recognized over the
vesting period, using the straight-line method. Since the award requires both
the completion of 4 years of service and the share price reaching predetermined
levels as defined in the option agreement, compensation cost will be recognized
over the 4 year explicit service period.  If the employee terminates
prior to the four-year requisite service period, compensation cost will be
reversed even if the market condition has been satisfied by that time. The total
grant date fair value of the options granted during 2008 using the Monte Carlo
valuation model was $1,026.
 
 27
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   12.
Stock Plans (continued)
   The
following table provides the assumptions used in determining the fair value of
service based awards for the three months ended March 31, 2010 and the year
ended December 31, 2009, respectively.
  Quarter
      ended
                March
      31, 2010
                Service
      based awards
              
              
              Year
      ended
                December
      31, 2009
                Service
      based awardsExpected
      volatility
              
              
              63.38
              %
              
              
              62.70
      – 69.38
              %Expected
      dividends
              
              
              0
              
              
              
              0Expected
      term (in years)
              
              
              6.25
              
              
              
              3 -
      6.25Risk-free
      rate
              
              
              3.27
              %
              
              
              1.36
      - 3.09
              %
   A summary of the status of the Company’s stock options and restricted stock as
of March 31, 2010 and December 31, 2009 and changes during the period then ended
is as follows:
  Options
      & Restricted Stock Outstanding
              
              Options
      ExercisableShares
      Available for Grant
              
              Shares
              
              Wtd. Avg.
                Exercise
                Price
              
              Shares
              
              Wtd. Avg.
                Exercise
                PriceBalance
      at December 31, 2008
              1,732,506
              
              2,487,654
              
              $
              17.33
              
              447,854
              
              $
              14.01Granted
      – options
              (756,000)
              
              756,000
              
              
              6.12
              
              —
              
              
              —Exercised
              —
              
              (14,747)
              
              
              4.72
              
              —
              
              
              —Forfeited
      or expired
              55,000
              
              (55,000)
              
              
              22.76
              
              —
              
              
              —Balance
      at December 31, 2009
              1,031,506
              
              3,173,907
              
              $
              14.63
              
              696,407
              
              $
              17.68Granted
      – options
              (443,500)
              
              443,500
              
              
              10.50
              
              —
              
              
              —Granted
      – restricted stock
              (85,000)
              
              85,000
              
              
              —
              
              —
              
              
              —Exercised
              —
              
              (21,851)
              
              
              4.69
              
              —
              
              
              —Forfeited
      or expired
              5,200
              
              (5,200)
              
              
              24.39
              
              —
              
              
              —Balance
      at March 31, 2010
              508,206
              
              3,675,356
              
              $
              13.84
              
              1,196,906
              
              $
              20.65
  The total
intrinsic value of options and restricted stock outstanding, exercisable and
exercised for and during the three months ended March 31, 2010 was $14,494 and
$1,905 and $126, respectively.  The weighted average fair value for
options and restricted stock granted during the three months ended March 31,
2010 and the year ended December 31, 2009 was $7.11 and $3.50,
respectively.  The weighted average remaining contractual term of
options and restricted stock outstanding and exercisable at March 31, 2010 was
5.98 and 3.28 years, respectively.
  Between
January 1, 2010 and March 31, 2010, the Company granted to certain employees and
officers options to purchase an aggregate of 443,500 shares of the Company's
common stock at prevailing market price of $10.50 per share.
  On
February 17, 2010, the Company granted to certain executive officers shares of
restricted stock in aggregate of 85,000 shares, which will vest 25% per year on
each of February 17, 2011, February 17, 2012, February 17, 2013 and February 17,
2014.  In the event the certain executive officer ceases to be an
employee before these shares are fully vested, the unvested restricted shares
units will be forfeited to the Issuer. The grant date fair value of the
restricted stock was $10.50 per share.
  Between
January 1, 2009 and December 31, 2009, the Company granted options to
certain employees, officers and non-employee directors options to purchase an
aggregate of 756,000 shares of the Company's common stock at a weighted exercise
price of $6.12 per share. The Company granted the options at prevailing market
prices ranging from $4.74 to $13.38 per share.
   
 28
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   12.
Stock Plans (continued)
  A summary
of the status of the Company’s unvested stock options and restricted stock for
the periods ended March 31, 2010 and December 31, 2009 is presented
below:
  Nonvested
      Shares
              
              Shares
              
              
              Wtd. Avg.
                Grant
      Date Fair ValueNonvested
      at December 31, 2008
              
              2,039,800
              
              
              $
              8.24Granted
      – options
              
              756,000
              
              
              
              3.50Vested
              
              (279,000
              )
              
              
              9.21Forfeited
      or expired
              
              (39,300
              )
              
              
              11.11Nonvested
      at December 31, 2009
              
              2,477,500
              
              
              
              6.34Granted
      – options
              
              443,500
              
              
              
              6.46Granted
      – restricted stock
              
              85,000
              
              
              
              10.50Vested
              
              (522,750
              )
              
              
              10.43Forfeited
      or expired
              
              (4,800
              )
              
              
              11.51Nonvested
      at March 31, 2010
              
              2,478,450
              
              
              $
              5.63
   In
accordance with FASB ASC 718, “Compensation-Stock
Compensation,” excess tax benefits, associated with the expense
recognized for financial reporting purposes, realized upon the exercise of stock
options are presented as a financing cash inflow rather than as a reduction of
income taxes paid in our consolidated statement of cash flows.  In
addition, the Company classifies share-based compensation within cost of
revenues, sales and marketing, general and administrative expenses and research
and development corresponding to the same line as the cash compensation paid to
respective employees, officers and non-employee directors.
   The
following table shows total share-based compensation expense included in the
accompanying Consolidated Statement of Operations:
  Three
      months ended
                March
      31,2010
              
              2009Cost
      of revenue
              
              $
              84
              
              $
              110Sales
      and marketing
              
              
              290
              
              
              239General
      and administrative
              
              
              820
              
              
              808Research
      and development
              
              
              97
              
              
              88Pre-tax
      share-based compensation
              
              
              1,291
              
              
              1,245Income
      tax benefit
              
              
              —
              
              
              —Share-based
      compensation expense, net
              
              $
              1,291
              
              $
              1,245
      
 29
 Table of Contents
 
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   12.
Stock Plans (continued)
  Employee
Stock Purchase Plan
  The
Employee Stock Purchase Plan, which was approved in May 2006, enables
substantially all U.S. and foreign employees to purchase shares of our common
stock at a 5% discounted offering price off the closing market price of our
common stock on the Nasdaq National Market, LLC on the offering
date.  We have granted rights to purchase up to 500,000 common shares
to our employees under the Plan. The Plan is not considered a compensatory plan
in accordance with FASB ASC 718 and requires no compensation expense to be
recognized.  Shares of our common stock purchased under the employee
stock purchase plan were 10,188 and 42,212 for the periods ended March 31, 2010
and December 31, 2009, respectively.  As of March 31, 2010 the shares
of common stock available to purchase under the employee stock purchase plan
were 410,307.
   13.  Related
Party Transactions
  One of
the Company's directors, Barry M. Abelson, is a partner in the law firm of
Pepper Hamilton LLP. This firm has represented the Company since 1997. For the
three months ended March 31, 2010 and 2009, the Company paid Pepper Hamilton
LLP, net of insurance coverage, $258 and $27, respectively, for general legal
matters.   The increase in payments to Pepper Hamilton LLP for
the three months ended March 31, 2010 as compared to previous years resulted
from our class action suits.  The amount payable to Pepper Hamilton as of
March 31, 2010 and December 31, 2009 was $272 and $202,
respectively.
   
 30
 Table of Contents
 
 Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
   14.
Geographic Information
  The
following table summarizes the distribution of revenue by geographic region as
determined by billing address for the three months ended March 31, 2010 and
2009.
  For
      the three months ended March 31,2010
              
              
              2009Country
              
              Amount
              
              Percent
      of
                Revenues
              
              
              Amount
              
              Percent
      of
                RevenuesUnited
      States
              
              $
              30,818
              
              
              77.7
              %
              
              $
              32,520
              
              
              83.7
              %United
      Kingdom
              
              
              2,634
              
              
              6.6
              %
              
              
              2,238
              
              
              5.8
              %Other
      European Countries
              
              
              1,720
              
              
              4.4
              %
              
              
              1,577
              
              
              4.1
              %Other
              
              
              1,536
              
              
              3.9
              %
              
              
              1,055
              
              
              2.7
              %Germany
              
              
              1,077
              
              
              2.7
              %
              
              
              928
              
              
              2.4
              %China
              
              
              907
              
              
              2.3
              %
              
              
              —
              
              
              0.0
              %Canada
              
              
              635
              
              
              1.6
              %
              
              
              41
              
              
              0.1
              %The
      Netherlands
              
              
              337
              
              
              0.8
              %
              
              
              472
              
              
              1.2
              %Total
              
              $
              39,664
              
              
              100.0
              %
              
              $
              38,831
              
              
              100.0
              %
   The
following table summarizes the distribution of assets by geographic region as of
March 31, 2010 and December 31, 2009.
  March
      31, 2010
              
              
              December
      31, 2009Country
              
              Assets
              
              Assets
      as a percentage of total assets
              
              
              Assets
              
              Assets
      as a percentage of total assetsUnited
      States
              
              $
              158,936
              
              
              77.3
              %
              
              $
              161,351
              
              
              79.7
              %United
      Kingdom
              
              
              13,192
              
              
              6.4
              %
              
              
              14,125
              
              
              7.0
              %India
              
              
              11,714
              
              
              5.7
              %
              
              
              9,943
              
              
              4.9
              %Ireland
              
              
              11,495
              
              
              5.6
              %
              
              
              4,182
              
              
              2.1
              %China
              
              
              2,999
              
              
              1.4
              %
              
              
              2,962
              
              
              1.5
              %Germany
              
              
              2,606
              
              
              1.3
              %
              
              
              4,381
              
              
              2.2
              %Canada
              
              
              2,489
              
              
              1.2
              %
              
              
              2,574
              
              
              1.3
              %Other
              
              
              2,229
              
              
              1.1
              %
              
              
              2,825
              
              
              1.3
              %Total
              
              $
              205,660
              
              
              100.0
              %
              
              $
              202,343
              
              
              100.0
              %
    
 31
 Table of Contents
 
 Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations
  This
Quarterly Report on Form 10-Q, including the following Management’s Discussion
and Analysis of Financial Condition and Results of Operations, contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as
amended, and the Private Securities Litigation Reform Act of 1995, that involve
a number of risks and uncertainties. These forward-looking statements include,
but are not limited to, plans, objectives, expectations and intentions and other
statements contained herein that are not historical facts and statements
identified by words such as “expects,” “anticipates,” “intends,” “plans,”
“believes,” “seeks,” “estimates” or words of similar meaning. These statements
may contain, among other things, guidance as to future revenue and earnings,
operations, prospects of the business generally, intellectual property and the
development of products.  These statements are based on our current
beliefs or expectations and are inherently subject to various risks and
uncertainties, including those set forth under the caption “Risk Factors” in our
most recent Annual Report on Form 10-K as filed with the Securities and Exchange
Commission, as amended and supplemented under the caption “Risk Factors” in our
subsequent Quarterly Reports on Form 10-Q filed with the Securities and Exchange
Commission.  Actual results may differ materially from these
expectations due to changes in global political, economic, business,
competitive, market and regulatory factors, our ability to implement business
and acquisition strategies or to complete or integrate
acquisitions.  We do not undertake any obligation to update any
forward-looking statements contained herein as a result of new information,
future events or otherwise. References herein to “Kenexa,” “we,” “our,” and “us”
collectively refer to Kenexa Corporation, a Pennsylvania corporation, and all of
its direct and indirect U.S., U.K., Canada, India, and other foreign
subsidiaries.
  1.
Overview
  We provide software, proprietary content and services that enable organizations
to more effectively recruit and retain employees. Our solutions are built around
a suite of easily configurable software applications that automate talent
acquisition and employee performance management best practices. We offer the
software applications that form the core of our on-demand solutions, which
materially reduces the costs and risks associated with deploying traditional
enterprise applications. We complement our software applications with tailored
combinations of outsourcing services, proprietary content and consulting
services based on our 22 years of experience assisting customers in
addressing their Human Resource (HR) requirements.  Together, our
software applications and services form complete and highly effective solutions
available from a single vendor. We believe that these solutions enable our
customers to improve the effectiveness of their talent acquisition programs,
increase employee productivity and retention, measure key HR metrics and make
their talent acquisition and employee performance management programs more
efficient.
  We sell our solutions to large and medium-sized organizations through our direct
sales force. As of December 31, 2009, we had a customer base of
approximately 4,900 companies, including approximately 170 companies on the
Fortune 500 list published in May 2009. Our customer base includes companies
that we billed for services during the 12 months ended December 31, 2009
and does not necessarily indicate an ongoing relationship with each such
customer. Our top 80 customers contributed approximately $21.6 million or 54.4%
of our total revenue for the three months ended March 31, 2010.
  Our customers typically purchase multi-year subscriptions which provide us with
a recurring revenue stream.  During the three months ended March 31,
2010 and year ended December 31, 2009, our customers renewed approximately
82% and 80%, respectively, of the aggregate value of multi-year subscriptions
for our on-demand talent acquisition and performance management solution
contracts subject to renewal.  This renewal rate provides us with a
strong base of recurring revenue. We believe that our strong customer
relationships provide us with a meaningful opportunity to cross-sell additional
solutions to our existing customers and to achieve greater penetration within an
organization. We expect to continue to create innovative programs designed to
provide our employees with strong incentives to maximize the value we provide to
each of our customers and as the business environment improves we expect renewal
rates to improve to our historical renewal rate of approximately 90% from a
long-term perspective.
 In March
2010, with a slight drop in the unemployment rate and a recent increase interest
in our product offerings, some of the uncertainties surrounding our business
began to lessen.  In light of these two factors, we are now cautiously
optimistic in the short term and more optimistic in the intermediate to longer
term around our prospects for continue growth.  However, given the
fragility of the economic recovery the timing of this anticipated growth
continues to be extremely difficult to predict.  We continue to
believe that, by optimizing our internal resources for the changing business
conditions, we can minimize these adverse effects and emerge from this economic
crisis with a return to our historic operating
margins.
 32
 Table of Contents
 
  2.
Recent Events
 
 On
January 20, 2009, we entered into an ownership interest transfer agreement with
Shanghai Runjie Management Consulting Company, (“R and J”) in Shanghai, China
for $1.3 million.  The initial investment provided us with a 46%
ownership in the new entity Shanghai Kenexa Human Resources Consulting Co.,
Ltd., (the “variable interest entity”) and a presence in China’s human capital
management market.  The agreement with R and J also provided for a 1%
annual ownership increase based upon adjusted EBITDA, as defined, for each of
the years ended 2008, 2009 and 2010.  In the third and fourth quarter
of 2009, based upon the 2008 operating results for R and J, we paid an
additional $0.2 million for an additional 1% ownership interest in the variable
interest entity.  The variable interest entity was financed with $0.3
million in initial equity contributions from us and R and J, and has no
borrowings for which its assets would be used as collateral.  On
September 30, 2009 we provided $0.2 million of financing for the variable
interest entity.  The creditors of the variable interest entity do not
have recourse to our other assets.
 
 On May 21, 2009, we elected not to renew our secured credit agreement with PNC
Bank.  We believe that our cash, short-term investments, UBS
Settlement Agreement for our auction rate securities and projected cash from
operations will be sufficient to meet our liquidity needs for at least the next
twelve months.
  On June 11, 2009 and July 16, 2009, two
putative class actions were filed against Kenexa Corporation and our Chief
Executive Officer and Chief Financial Officer in the United States District
Court for the Eastern District of Pennsylvania, purportedly on behalf of a class
of our investors who purchased our publicly traded securities between May 8,
2007 and November 7, 2007. The complaint filed on July 16, 2009 has since been
voluntarily dismissed.  In the pending action, Building Trades United
Pension Trust Fund, individually and on behalf of all others similarly situated
alleges violations of Section 10(b) of the Securities Exchange Act of 1934
("Exchange Act"), Rule 10b-5 promulgated thereunder and Section 20(a) of the
Exchange Act in connection with various public statements made by Kenexa. 
This action seeks unspecified damages, attorneys’ fees and
expenses.
      
 33
 Table of Contents
 
  3.
Sources of Revenue
  We derive revenue primarily from two sources:
(1) subscription revenue for our solutions, which is comprised of
subscription fees from customers accessing our on-demand software, consulting
services, outsourcing services and proprietary content, and from customers
purchasing additional support that is not included in the basic subscription
fee; and (2) fees for discrete professional services.
  Our customers primarily purchase renewable subscriptions
for our solutions. The typical term is one to three years, with some terms
extending up to five years. The majority of our subscription agreements are not
cancelable for convenience although our customers have the right to terminate
their contracts for cause if we fail to provide the agreed upon services or
otherwise breach the agreement. A customer does not generally have a right to a
refund of any advance payments if the contract is cancelled.  Due to
the current economic slowdown, a greater number of our customers are delaying or
seeking to revise the terms and conditions of our service
agreements.  As a result, during the three months ended March 31, 2010
and year ended December 31, 2009 our customers renewed approximately 82% and
80%, respectively, of the aggregate value of multi-year subscriptions for our
on-demand talent acquisition and performance management solution contracts
subject to renewal during the period rather than our historical renewal rate of
approximately 90%.  As the business environment improves we expect
renewal rates to improve to the 90% range from a long-term
perspective.
  Consistent with our historical practices, revenue
derived from subscription fees is recognized ratably over the term of the
subscription agreement. We generally invoice our customers in advance in
quarterly installments and typical payment terms provide that our customers pay
us within 30 days of invoice. Amounts that have been invoiced are recorded in
accounts receivable prior to the receipt of payment and in deferred revenue to
the extent revenue recognition criteria have not been met.  As of
March 31, 2010, deferred revenue increased by $4.5 million or 9.1% to $54.5
million from $50.0 million at December 31, 2009.  The increase in
deferred revenue is a result of the increase in sales of our multiple elements
or bundled arrangements.  We generally price our solutions based on
the number of software applications and services included and the number of
customer employees. Accordingly, subscription fees are generally greater for
larger organizations and for those that subscribe for a broader array of
software applications and services.
  We derive other revenue from the sale of discrete
professional services, and translation services as well as from out-of-pocket
expenses. The majority of our other revenue is derived from discrete
professional services, which primarily consist of consulting and training
services. This revenue is recognized differently depending on the type of
service provided as described in greater detail below under “Critical Accounting
Policies and Estimates.”
  For the three months ended March 31, 2010, approximately
77.7% of our total revenue was derived from sales in the United States. Revenue
that we generated from customers in the United Kingdom, Germany and China was
approximately 6.6%, 2.7% and 2.3%, respectively, for the three months ended
March 31, 2010. Revenue for all other countries amounted to an aggregate of
10.7%. Other than the countries listed, no other country represented more than
2.0% of our total revenue for the quarter ended March 31,
2010.
 
 34
 Table of Contents
 
 4.
Key Performance Indicators
  The following tables summarize the key performance indicators that we consider
to be material in managing our business, in thousands (other than
percentages):
  For
      the year ended December 31,
              
              
              For
      the three months ended
                March
      31,2009
              
              
              2010
              
              
              2009(unaudited)
              
              
              (unaudited)Total
      Revenue
              
              $
              157,669
              
              
              $
              39,664
              
              
              $
              38,831Subscription
      revenue as a percentage of total revenue
              
              
              84.9
              %
              
              
              83.8
              %
              
              
              85.7
              %Non-GAAP
      income from operations
              
              $
              15,915
              
              
              $
              2,274
              
              
              $
              3,932Net
      cash provided by operating activities
              
              $
              35,320
              
              
              $
              8,806
              
              
              $
              8,880
   As
      of
                December
      31,
              
              
              As
      of March 31,2009
              
              
              2010
              
              
              2009Deferred
      revenue
              
              $
              49,964
              
              
              $
              54,504
              
              
              $
              41,427
   The
following is a discussion of significant terms used in the tables
above.
  Subscription
revenue as a percentage of total revenue. Subscription revenue as a
percentage of total revenue can be derived from our consolidated statements of
operations. This performance indicator illustrates the evolution of our business
towards subscription-based solutions, which provides us with a recurring revenue
stream and which we believe to be a more compelling revenue growth and
profitability opportunity.  We expect that the percentage of
subscription revenue will be within a target range of 78% to 82% of our total
revenues in 2010.
  Net
cash provided by operating activities. Net cash
provided by operating activities is taken from our consolidated statement of
cash flows and represents the amount of cash generated by our operations that is
available for investing and financing activities. Generally, our net cash
provided by operating activities has exceeded our operating income primarily due
to the positive impact of deferred revenue, the add-back of non-cash goodwill
impairment charges and more recently due to the collection of accounts
receivables. It is possible that this trend may vary as business conditions
change.
   
 35
 Table of Contents
  Deferred
revenue. We generate revenue primarily from multi-year subscriptions for
our on-demand talent acquisition and employee performance management solutions.
We recognize revenue from these subscription agreements ratably over the hosting
period, which is typically one to three years. We generally invoice our
customers in quarterly or monthly installments in advance. Deferred revenue,
which is included in our consolidated balance sheets, is the amount of invoiced
subscriptions in excess of the amount recognized as revenue. Deferred revenue
represents, in part, the amount that we will record as revenue in our
consolidated statements of operations in future periods. As the subscription
component of our revenue has grown and customer willingness to pay us in advance
for their subscriptions has increased, the amount of deferred revenue on our
balance sheet has grown.  It is possible that this trend may vary as
business conditions change.
  The following table reconciles beginning and ending deferred revenue for each of
the periods shown:
  For
      the year ended December 31,
              
              
              For
      the three months ended March 31,2009
              
              
              2010
              
              
              2009(unaudited)
              
              
              (unaudited)Deferred
      revenue at the beginning of the year
              
              $
              38,638
              
              
              $
              49,964
              
              
              $
              38,638Total
      invoiced subscriptions during the period
              
              
              145,180
              
              
              
              37,792
              
              
              
              36,054Subscription
      revenue recognized during the period
              
              
              (133,854
              )
              
              
              (33,252
              )
              
              
              (33,265
              )Deferred
      revenue at end of period
              
              $
              49,964
              
              
              $
              54,504
              
              
              $
              41,427
   Non-GAAP
income from operations.Non-GAAP income from operations is
derived from income (loss) from operations adjusted for noncash or nonrecurring
expenses.  We believe that measuring our operations, using non-GAAP
income from operations provides more useful information to management and
investors regarding certain financial and business trends relating to our
financial condition and ongoing results.   We use these measures
to compare our performance to that of prior periods for trend analyses, for
purposes of determining executive incentive compensation, and for budget and
planning purposes.  These measures are used in monthly financial
reports prepared for management and in quarterly financial reports presented to
our Board of Directors.  We believe that the use of these non-GAAP
financial measures provides an additional tool for investors to use in
evaluating ongoing operating results and trends and in comparing its financial
measures with other companies in our industry, many of which present similar
non-GAAP financial measures to investors.
  We do not
consider such non-GAAP measures in isolation or as an alternative to such
measures determined in accordance with GAAP. The principal limitation of such
non-GAAP financial measures is that they exclude significant expenses that are
required by GAAP to be recorded.  In addition, they are subject to
inherent limitations as they reflect the exercise of judgments by management
about which charges are excluded from the non-GAAP financial
measures.
  In order
to compensate for these limitations, we present our non-GAAP financial measures
in connection with our GAAP results.  We urge investors to review the
reconciliation of our non-GAAP financial measures to the comparable GAAP
financial measures included below, and not to rely on any single financial
measure to evaluate our business.
   For
      the year ended
                December 31,
              
              
              For the three months ended
                March 31,2009
              
              
              2010
              
              2009(unaudited)
              
              (unaudited)(Loss)
      income from operations
              
              $
              (29,035
              )
              
              $
              62
              
              $
              (33,568
              )Share-based
      compensation expense
              
              
              5,364
              
              
              
              1,291
              
              
              1,245Amortization
      of acquired intangibles
              
              
              4,475
              
              
              
              921
              
              
              1,083Professional
      fees associated with variable interest entity
              
              
              687
              
              
              
              —
              
              
              687Severance
      expense
              
              
              1,156
              
              
              
              —
              
              
              1,156Goodwill
      impairment charge
              
              
              33,329
              
              
              
              —
              
              
              33,329Noncontrolling
      interests
              
              
              (61
              )
              
              
              —
              
              
              —Non-GAAP
      income from operations
              
              $
              15,915
              
              
              $
              2,274
              
              $
              3,932
  
 36
 Table of Contents
 
  Our
non-GAAP financial measures as set forth in the table above exclude the
following:
  Share-based
compensation.  Share-based compensation consists of expenses
for stock options and stock awards that we began recording in accordance
with ASC 718 during the first quarter of 2006. Share-based
compensation expenses are excluded in our non-GAAP financial measures because
share-based compensation amounts are difficult to forecast. This is due in part
to the magnitude of the charges which depends upon the volume and timing of
stock option grants, which are unpredictable and can vary dramatically from
period to period, and external factors such as interest rates and the trading
price and volatility of our common stock.  We believe that this
exclusion provides meaningful supplemental information regarding our operating
results because these non-GAAP financial measures facilitate the comparison of
results for future periods with results from past periods. The dilutive effect
of all outstanding options is included in the calculation of diluted earnings
per share on both a GAAP and a non-GAAP basis.
  Amortization of intangibles associated with
acquisitions. In accordance with GAAP, operating expenses include
amortization of acquired intangible assets which are amortized over the
estimated useful lives of such assets.  Amortization of acquired
intangible assets is excluded from our non-GAAP financial measures because we
believe that such exclusion facilitates comparisons to its historical operating
results and to the results of other companies in the same industry, which have
their own unique acquisition histories.
  Professional fees associated with variable interest
entity.  These charges are related to our variable interest
entity in China.  We believe that such exclusion facilitates
comparisons to our historical operating results and to the results of other
companies in the same industry, which have their own unique acquisition
histories.
  Severance expense. These charges were
excluded in computing our non-GAAP income to facilitate a more
meaningful comparison to the prior year’s results.
  Goodwill impairment charge. We recorded a
non-cash goodwill impairment charge as a result of a substantial decrease in our
stock price, reflecting the impact of the unprecedented turmoil in world
economies and the resultant impact on our operations.
  Noncontrolling
interests.   Noncontrolling interest includes income from
operations due to our variable interest entity partner and is excluded from the
calculation of non-GAAP net income from operations because it is unrelated to
our ownership in the venture.
      
 37
 Table of Contents
 
 5.
Results of Operations
  Three
months ended March 31, 2010 compared to three months ended March 31,
2009
  The following table sets forth for the periods
indicated, the amount and percentage of total revenues represented by certain
items reflected in our unaudited consolidated statements of operations:
  Kenexa
Corporation Consolidated Statements of Operations
 (In
thousands)
 (Unaudited)
  For
      the three months ended March 31,2010
              
              
              2009Amount
              
              
              Percent
      of
                Revenues
              
              
              Amount
              
              
              Percent
      of
                RevenuesRevenue:Subscription
              
              $
              33,252
              
              
              
              83.8
              %
              
              $
              33,265
              
              
              85.7
              %Other
              
              
              6,412
              
              
              
              16.2
              %
              
              
              5,566
              
              
              14.3
              %Total
      revenue
              
              
              39,664
              
              
              
              100.0
              %
              
              
              38,831
              
              
              100.0
              %Cost
      of revenue
              
              
              13,811
              
              
              
              34.8
              %
              
              
              13,696
              
              
              35.3
              %Gross
      profit
              
              
              25,853
              
              
              
              65.2
              %
              
              
              25,135
              
              
              64.7
              %Operating
      expenses:Sales
      and marketing
              
              
              9,640
              
              
              
              24.3
              %
              
              
              8,705
              
              
              22.4
              %General
      and administrative
              
              
              9,831
              
              
              
              24.8
              %
              
              
              10,873
              
              
              28.0
              %Research
      and development
              
              
              2,284
              
              
              
              5.8
              %
              
              
              2,568
              
              
              6.6
              %Depreciation
      and amortization
              
              
              4,036
              
              
              
              10.2
              %
              
              
              3,228
              
              
              8.3
              %Goodwill
      impairment charge
              
              
              —
              
              
              
              —
              %
              
              
              33,329
              
              
              85.8
              %Total
      operating expenses
              
              
              25,791
              
              
              
              65.1
              %
              
              
              58,703
              
              
              151.1
              %Income
      (loss) from operations
              
              
              62
              
              
              
              0.1
              %
              
              
              (33,568
              )
              
              (86.4
              )
      %Interest
      income, net
              
              
              146
              
              
              
              0.4
              %
              
              
              63
              
              
              0.2
              %Loss
      on change in fair market value of ARS and put option, net
              
              
              (31
              )
              
              
              (0.1
              )
      %
              
              
              (295
              )
              
              (0.8
              )
      %Income
      (loss) before income taxes
              
              
              177
              
              
              
              0.4
              %
              
              
              (33,800
              )
              
              (87.0
              )
      %Income
      tax expense
              
              
              133
              
              
              
              0.3
              %
              
              
              482
              
              
              1.2
              %Net
      income (loss)
              
              
              44
              
              
              
              0.1
              %
              
              
              (34,282
              )
              
              (88.2
              )
      %Income
      allocated to noncontrolling interests
              
              
              (62
              )
              
              
              (0.2
              )
      %
              
              
              —
              
              
              —
              %Net
      loss allocable to common shareholders
              
              $
              (18
              )
              
              
              (0.1
              )
      %
              
              $
              (34,282
              )
              
              (88.2
              )
      %
 
 38
 Table of Contents
 
  Revenue
  Total
revenue increased $0.9 million or 2.1% to $39.7 million, subscription revenue
remained the same at $33.3 million and other revenue increased $0.9 million or
15.2 % to $6.4 million for the three months ended March 31, 2010, compared to
the same period in 2009.  Subscription revenue represented
approximately 83.8% of our total revenue for the three months ended March 31,
2010.  The increase in revenue is attributable primarily to our
adoption of ASU 2009-13, which contributed $0.7 million to the
increase. Deferred
implementation costs recognized in connection with our adoption of ASU 2009-13
were approximately $0.5 million for the three months ended March 31,
2010. Based upon the current market conditions,
we expect our subscription-based and other revenues to increase in 2010 over the
prior year due to stabilization in the unemployment rate, slightly improved
business environment and continued acceptance of our talent management solutions
on-demand model.
   Cost
of Revenue
  Our cost of revenue primarily consists of compensation,
employee benefits and out-of-pocket travel-related expenses for our employees
and independent contractors who provide consulting or other professional
services to our customers. Additionally, our application hosting costs,
amortization of third-party license royalty costs, technical support personnel
costs, overhead allocated based on headcount and reimbursed expenses are also
recorded as cost of revenue.  Many factors affect our cost of revenue,
including changes in the mix of products and services, pricing trends, changes
in the amount of reimbursed expenses and fluctuations in our customer base.
Because cost as a percentage of revenue is higher for professional services than
for software products, an increase in the services component of our solutions or
an increase in discrete professional services as a percentage of our total
revenue would reduce gross profit as a percentage of total
revenue.  As our revenues begin to increase, we expect our cost of
revenue to increase proportionately, subject to pricing pressure related to
economic conditions and slightly influenced by the mix of services and software.
To the extent new customers are added, we expect that the cost of services, as a
percentage of revenue, will be greater than those services associated with
existing customers.
  Cost of
revenue increased by $0.1 million or 0.8% to $13.8 million during the three
months ended March 31, 2010, compared to the same period in 2009. The $0.1
million increase for the three months ended March 31, 2010 was due to a
reduction in severance expense of $0.7 million offset by an increase in
staff  related expense of $0.8 million.As a
percentage of revenue cost of revenue decreased by 0.5% to 34.8% for the three
months ended March 31, 2010, compared to the same period in 2009.
   Sales
and Marketing Expense
  Sales and marketing expenses primarily consist of
personnel and related costs for employees engaged in sales and marketing,
including salaries, commissions, and other variable compensation, travel
expenses and costs associated with trade shows, advertising and other marketing
efforts and allocated overhead. We expense our sales commissions at the time the
related revenue is recognized, and we recognize revenue from our subscription
agreements ratably over the terms of the agreements.  Consistent with
our past practice, we intend to continue to invest in sales and marketing to
pursue new customers and expand relationships with existing customers at levels
we deem appropriate given our current economic conditions.  We expect
our sales and marketing expense to increase from current levels, mainly due to
increased staff expense and continued emphasis on our rebranding
effort.
  Sales and
marketing expense increased $1.0 million or 10.7 % to $9.7 million during the
three months ended March 31, 2010, compared to the same period in 2009. The $1.0
million increase for the three months ended March 31, 2010 was due primarily to
increased staff and staff related expense and travel expense which totaled $1.2
million, partically offset by a $0.2 decrease in severance
expense.    In addition, third party consultants and
marketing expense of $0.5 million was offset by a decrease in bonus expense of
$0.5 million compared to the same period in 2009.  As a percentage of
revenue, sales and marketing expense increased from 22.4 % to 24.3%, for the
three months ended March 31, 2010.
   
 39
 Table of Contents
 
 General
and Administrative Expense
  General
and administrative expenses primarily consist of personnel and related costs for
our executive, finance, human resources and administrative personnel,
professional fees and other corporate expenses and allocated
overhead.  We expect general and administrative expenses to increase
in the short term as we incur additional professional fees in connection with
our patent infringement matter, however, in the longer term based upon the
current state of the economy, we believe that general and administrative
expenses will remain the same or slightly increase in dollar amount and remain
constant as a percentage of total revenue in 2010.
  General
and administrative expense decreased $1.1 million or 9.6% to $9.8 million during
the three months ended March 31, 2010, compared to the same period in 2009. The
$1.1 million decrease for the three months ended March 31, 2010 was due
primarily to a decrease in staff related expense, severance, bonus, and
professional fees of $0.4 million, $0.2 million, $0.2 million, and $0.3 million,
respectively, during the three months ended March 31, 2010, compared to the same
period in 2009.  The decrease in
professional fees is comprised of a reduction in variable interest entity setup
fees of $0.6 million partially offset by an increase in litigation expense of
$0.3 million for the three months ended March 31, 2010, compared to the same
period in 2009.As a percentage of revenue, general and
administrative expense decreased from approximately 28.0% to 24.8% for the three
months ended March 31, 2010, compared to the same period in 2009.
   Research
and Development (“R&D”) Expense
  Research
and development expenses primarily consist of personnel and related costs,
including salaries, and employee benefits, for software engineers, quality
assurance engineers, product managers, technical sales engineers and management
information systems personnel and third party consultants.  Our
research and development efforts have been devoted primarily to new product
offerings and enhancements and upgrades to our existing products.  We
expect research and development expenses to remain flat or increase slightly as
we continue to execute on our strategies which include furthering the common
services enterprise architecture, introducing Kenexa 2x modules, and continuing
to develop feature enhancements.
  Research
and development expense decreased $0.3 million or 11.1% to $2.3 million during
the three months ended March 31, 2010, compared to the same period in
2009.   The $0.3 million decrease was due primarily to a
reduction in staff expense, which included $0.1 million of severance
expense.  As a percentage of revenue, research and development expense
decreased from approximately 6.6% to 5.8% for the three months ended March 31,
2010, compared to the same period in 2009.
   Depreciation
and Amortization
  Depreciation and amortization expense increased $0.8
million or 25.0% to $4.0 million during the three months ended March 31, 2010,
compared to the same period in 2009.  The $0.8 million increase was
due primarily to increased depreciation expense associated with our capitalized
software and equipment purchases.  In the future, we expect
depreciation and amortization expense to increase due to recent capital
purchases and as we place our software development costs into
service.  The increase in capitalized software development costs is
directly attributable to an increase in the software development projects
qualifying for capitalization, pursuant to ASC 350-40, “Internal-Use
Software.”
   Income
Tax Expense
  Income tax expense decreased $0.3 million or 72.4% to
$0.2 million during the three months ended March 31, 2010, compared to the same
period in 2009.  The decrease in income tax expense is primarily due
to lower taxable income and a larger portion of our taxable income being
generated in jurisdictions with lower effective tax rates and also decreasing in
jurisdictions with higher tax rates.
  
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 Table of Contents
 
 6.
Liquidity and Capital Resources
  Since we
were formed in 1987, we have financed our operations primarily through
internally generated cash flows, our revolving credit facilities and the
issuance of equity. As of March 31, 2010, we had cash and cash equivalents
of $38.3 million and investments of $24.3 million. In addition, we had no debt
and approximately $0.4 million in capital equipment leases.  Cash held
in foreign denominated currencies were $17.7 million or 46.3% of our total cash
balance as of March 31, 2010.  A ten percent change in the exchange
rate of the underlying currencies would have a material impact on our foreign
exchange impact on cash on our statement of cash
flows.
 Our
cash provided from operations was $8.8 million and $8.9 million for the three
months ended March 31, 2010 and 2009.  Cash provided by and (used in)
investing activities was $0.4 million and $(3.2) million for the three months
ended March 31, 2010 and 2009.  Cash provided by financing activities
was $0.1 million for the three months ended March 31, 2010 and less than $0.1
million for the three months ended March 31, 2009.  Our net increase
in cash and cash equivalents was $9.1 million for the three months ended March
31, 2010, resulting primarily from our operating activities.  Our net
increase in cash and cash equivalents was $5.3 million for the three months
ended March 31, 2009, resulting primarily from our operating
activities.   While our investing and financing activities have
been significant over the past three years, we expect positive cash flow from
operations to continue in future periods.
  As of
March 31, 2010, we held auction rate securities with a fair value of $10.2
million and par value of $11.3 million. Our auction rate securities portfolio
includes investments rated A, AA and AAA and are comprised of federally and
privately insured student loans. The auction rate securities we hold have
continued to fail to trade at recent auctions due to insufficient bids from
buyers. This limits the short-term liquidity of these instruments and may limit
our ability to liquidate and fully recover the carrying value of our auction
rate securities if we needed to convert some or all to cash in the near term.
Despite the current lack of liquidity in the auction rate security market, we
believe our current cash and cash equivalent balances and cash from operations
will be sufficient to fund our operations.
  Our
auction rate securities were acquired through UBS AG.  Due to the
failure of the auction rate market in early 2008, UBS and other major banks
entered into agreements with governmental agencies to provide liquidity to
owners of auction rate securities. In November 2008, we entered into an
agreement with UBS which provides us (1) with a “no net cost” loan up to the par
value of Eligible ARS until September 30, 2010, (2) the right to sell these
auction rate securities back to UBS AG at par, at our sole discretion, anytime
during the period from June 30, 2010 through July 2, 2012, and
(3) provides UBS AG the right to purchase these auction rate securities or
sell them on our behalf at par anytime through July 2,
2012.  Refer to Footnote 3 – Investments of the Notes to Consolidated
Financial Statements for additional information.
  On May
31, 2009, we elected not to renew our secured credit agreement with our bank and
as a result, no longer have a revolving credit facility or other debt financing
arrangement.  We believe that our cash and short-term investments, our
UBS Settlement Agreement for our auction rate securities and our projected cash
from operations will be sufficient to meet our liquidity needs for at least the
next twelve months.
  
 41
 Table of Contents
  Operating
Activities
  Our largest source of operating cash flows is cash
collections from our customers following the purchase and renewal of their
software subscriptions. Payments from customers for subscription agreements are
generally received near the beginning of the contract term, which can vary from
one to three years in length. We also generate significant cash from our
recruitment process outsourcing services and to a lesser extent our consulting
services. Our primary uses of cash from operating activities are for personnel
related expenditures as well as payments related to taxes and leased
facilities.
  Net cash
provided by operating activities was $8.8 million and $8.9 million for the three
months ended March 31, 2010 and 2009, respectively.  Net cash provided
by operating activities for the three months ended March 31, 2010 resulted
primarily from non-cash charges to net income of approximately $5.5 million, an
increase in deferred revenue of $4.7 million, and a decrease in accounts
receivables of $1.4 million offset by changes in working capital of $2.8
million.  Net cash provided by operating activities for the three
months ended March 31, 2009 resulted primarily from a net loss of approximately
$34.3 million, changes in working capital of $2.7 million offset by non-cash
charges to net income of $4.8 million, a non-cash goodwill impairment charge of
$33.3 million, an increase in deferred revenue of $2.6 million, and a decrease
in accounts receivables of approximately $5.2 million.
   Investing
Activities
  Net cash
provided by and (used in) investing activities was $0.4 million and $(3.2)
million for the three months ended March 31, 2010 and 2009,
respectively.  Cash flows used in investing activities consisted
primarily of adjustments for earnouts, taxes, escrow payments, acquisitions and
additional capital equipment as follows:
  For
      the three months ended March 31,
                2010
              
              
              For
      the three months ended March 31,
                2009Quorum
      acquisition
              
              $
              (1.6
              )
              
              $
              (0.4
              )Capitalized
      software and purchases of property and equipment
              
              
              (3.6
              )
              
              
              (3.0
              )Purchases
      of available-for-sale securities
              
              
              (0.7
              )
              
              
              (0.8
              )Sales
      of available-for-sale securities
              
              
              2.2
              
              
              
              1.2Sales
      of trading securities
              
              
              4.1
              
              
              
              1.2Investment
      in joint venture
              
              
              —
              
              
              
              (1.4
              )Total
      cash flows provided by (used in) by investing activities
              
              $
              0.4
              
              
              $
              (3.2
              )
   Financing
Activities
  Net cash
provided by financing activities was $0.1 million and less than $0.1 million for
the three months ended March 31, 2010 and 2009, respectively.  For the
three months ended March 31, 2010, net cash provided by financing activity
resulted primarily from net proceeds from stock option exercises of $0.1 million
and share issuance from our employee stock purchase plan of $0.1 million
partially offset by repayments of capital lease obligations and notes payable of
$0.1 million.
    
 42
 Table of Contents
 
 Critical
Accounting Policies and Estimates
  Our discussion and analysis of our financial condition
and consolidated results of operations are based upon our consolidated financial
statements, which have been prepared in accordance with generally accepted
accounting principles in the United States. The preparation of our consolidated
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenue and expenses and related
disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to uncollectible accounts
receivable and accrued expenses. We base these estimates on historical
experience and various other assumptions that we believe to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Our actual results may differ from these
estimates.
  We believe that the following critical accounting
policies affect our more significant estimates and judgments used in the
preparation of our consolidated financial statements:
  Revenue
Recognition
  We derive our revenue from two sources:
(1) subscription revenues for solutions, which are comprised of
subscription fees from customers accessing our on-demand software, consulting
services, outsourcing services and proprietary content, and from customers
purchasing additional support beyond the standard support that is included in
the basic subscription fee; and (2) other fees for professional services,
translation services and reimbursed out-of-pocket expenses. Because we provide
our solutions as a service, we follow the provisions of Financial Accounting
Standards Board (“FASB”) ASC 605-10, “Revenue
Recognition” and FASB ASC 605-25 “Multiple Element
Arrangements.”We recognize revenue when all of the following
conditions are met:
  •
              there
      is persuasive evidence of an arrangement;•
              the
      service has been provided to the customer;•
              the
      collection of the fees is probable; and•
              the
      amount of fees to be paid by the customer is fixed or
      determinable.
  Subscription
Fees and Support Revenues. Subscription fees and support revenues are
recognized ratably over the lives of the contracts.  Amounts that have
been invoiced are recorded in accounts receivable and in deferred revenue or
revenue, depending on whether the revenue recognition criteria have been
met.
  Other
Revenue. Other revenue consists of discrete professional services,
translation services and reimbursable out-of-pocket expenses. Discrete
professional services, when sold with subscription and support offerings, are
accounted for separately since these services have value to the customer on a
stand-alone basis and there is objective and reliable evidence of fair value of
the delivered elements.  Our arrangements do not contain general
rights of return.  Additionally, when professional services are sold
with other elements, the consideration from the revenue arrangement is allocated
among the separate elements based upon the relative fair value. Revenues from
professional services are recognized based upon proportional performance as
value is delivered to the customer.
  In
determining whether revenues from professional services can be accounted for
separately from subscription revenue, we consider the following factors for each
agreement: availability of professional services from other vendors, whether
objective and reliable evidence of the fair value exists of the undelivered
elements, the nature and the timing of when the agreement was signed in
comparison to the subscription agreement start date and the contractual
dependence of the subscription service on the customer's satisfaction with the
other services. If the professional service does not qualify for separate
accounting, we recognize the revenue ratably over the remaining term of the
subscription contract. In these situations we defer the direct and incremental
costs of the professional service over the same period as the revenue is
recognized.
  In
accordance with FASB ASC 605-45, “Principal Agent
Considerations,” we record reimbursements received for out-of-pocket
expenses as revenue and not netted with the applicable costs.  These
items primarily include travel, meals and certain telecommunication
costs.  Reimbursed expenses totaled $0.5 million for the three months
ended March 31, 2010 and 2009.
  Pursuant to the transition rules contained in Accounting
Standards Update 2009-13 (“ASU 2009-13”), “Multiple
Deliverable Revenue Arrangements,” we elected to adopt early the
provisions included in the amendment effective January 1,
2010.
  
 43
 Table of Contents
  Based
upon a review of our applicant tracking system arrangements (“ATS”) we
determined that implementation services, previously combined with hosting fees
as one unit of accounting, now qualify as a separate unit of
accounting.  This new approach is supported by the existence of our
estimated selling prices for all of our deliverables within an ATS arrangement
and the assertion that the delivered items within these arrangements, i.e. the
implementation services, have standalone value.  Under these
arrangements, contract consideration will be allocated to each deliverable using
the relative selling price method.  As a result of this adoption,
implementation revenue previously recognized over the license term, will be
recognized in the period the service is provided which corresponds to value
delivered to the customer.
  In
addition to modifying revenue recognition for ATS arrangements, the new guidance
contained in ASU 2009-13 permits us to unbundle multiple products within an
arrangement using the relative selling price
method.   Previously, these deliverables were treated as one unit
of accounting with revenue under these arrangements being deferred until all
products, for which we lacked objective evidence of fair value, were
delivered.  Under the new guidance, total consideration will be
allocated to each product based using the relative selling price method and
recognized as each product is delivered to the customer.  In addition,
the new guidance prohibits the use of the residual method for determining the
value of delivered element.
  Based
upon a preliminary analysis we have determined that the adoption of ASU 2009-13
will not have a material impact on the financial statements after the initial
adoption.  This conclusion is based in part on the following
facts:
  •
              Revenue
      that would have been recognized through March 31, 2010 if the related
      arrangements entered into or materially modified after the effective date
      were subject to the measurement requirements of ASC 605-25 would have been
      $0.7 million or 1.8% less than currently reported revenue of $39.7
      million, for the three months ended March 31, 2010.•
              Revenue
      that would have been recognized in the year before the year of adoption if
      the arrangements accounted for under ASC 605-25 were subject to the new
      measurement requirements of ASU 2009-13 would have been $0.02 million or
      less than 0.01% greater than the reported revenue of $38.8 million, for
      the three months ended March 31, 2009.•
              Revenue
      recognized and deferred revenue as of and for the quarter ended March 31,
      2010 from applying ASC 605-25  and ASU 2009-13:
   Revenue
      recognized
                
                Deferred
      revenueASC
      605-25
                
                $
                39.0
                
                $
                51.3ASU
      2009-13
                
                
                0.7
                
                
                3.2Total
                
                $
                39.7
                
                $
                54.5
 The new revenue guidance contained in ASU 2009-13
modifies the way we account for our ATS arrangements, by allowing us to separate
the implementation services and corresponding license fees into two
separate units of accounting.  These two deliverables represent the
primary elements in an ATS arrangement and are recognized upon performance or
delivery of each service or product, respectively to the end
customer.  The implementation services are typically earned over a
three to six month period, while the license fees are recognized over a two to
five year period.  These arrangements usually do not contain
cancellation or refund-type provisions and may include termination for
convenience clauses following a stated period of time or performance level
commitments.
  Multiple element arrangements consisting of multiple
products are also impacted by the new revenue guidance.  Under ASU
2009-13 total consideration for an arrangement is allocated to each product
using the relative selling price method and revenue is recognized upon delivery
of the product or service.  Consistent with current practice, revenue
may be deferred if the arrangement includes any unusual terms including extended
payment terms, specified acceptance terms, or hold backs payable upon final
acceptance of the product.
   
 44
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 We
utilize a pricing model for our products which considers market factors such as
customer demand for its products, competitor’s pricing and the geographic
regions where the products are sold.  In addition, the model considers
entity-specific factors such as volume based pricing, discounts for bundled
products, total contract commitment and the number of required languages for the
product.  The pricing model for the individual or bundled arrangement
includes a price floor amount, which provides for a 15% discount on the bundled
price, and an actual quote to determine if the quote is within an acceptable
range for management’s approval.  Including this final verification in
the model ensures that all of our selling prices are consistent and within an
acceptable range for use with the relative selling price method.
  While the pricing model, currently in use, captures all
critical variables, unforeseen changes due to external market forces may result
in us revising some of the inputs.  These modifications may result in
the consideration allocation differing from the one presently in
use.  Absent a significant change in the pricing inputs or the way in
which the industry structures its deals, future changes in the pricing model are
not expected to materially affect our allocation of arrangement
consideration.
   Allowance
for Doubtful Accounts
  We
maintain an allowance for doubtful accounts for estimated losses resulting from
customers’ inability to pay us. The provision is based on our historical
experience and for specific customers that, in our opinion, are likely to
default on our receivables from them. In order to identify these customers, we
perform ongoing reviews of all customers that have breached their payment terms,
as well as those that have filed for bankruptcy or for whom information has
become available indicating a significant risk of non-recoverability. We rely on
historical trends of bad debt as a percentage of total revenue and apply these
percentages to the accounts receivable associated with new customers and
evaluate these customers over time. To the extent that our future collections
differ from our assumptions based on historical experience, the amount of our
bad debt and allowance recorded may be different.
   Capitalized
Software Development Costs
  In
accordance with FASB ASC 985, “Software,”
and FASB ASC 350, “Intangibles-Goodwill
and Other,” costs incurred in the preliminary stages of a development
project are expensed as incurred.  Once an application has reached the
development stage, internal and external costs, if direct and incremental, will
be capitalized until the software is substantially complete and ready for its
intended use. Capitalization ceases upon completion of all substantial testing.
We also capitalize costs related to specific upgrades and enhancements when it
is probable the expenditures will result in additional functionality.
Maintenance and training cost are expensed as incurred.  Internal use
software is amortized on a straight-line basis over its estimated useful life,
generally three years. Management evaluates the useful lives of these assets on
an annual basis and tests for impairments whenever events or changes in
circumstances occur that could impact the recoverability of these assets. There
were no impairments to internal software in any of the periods covered in this
report.  We have capitalized software costs of $2.7 million and $9.7
million for the three months ended March 31, 2010 and the year ended December
31, 2009, respectively.
 
 45
 Table of Contents
 
 Goodwill
and Other Identified Intangible Asset Impairment
  Since 2002, we have recorded goodwill in accordance with
the provisions of FASB ASC 350, “Intangibles-Goodwill
and Other,” which requires us to annually review the carrying value of
goodwill for impairment.  If goodwill becomes impaired, some or all of
the goodwill would be written off as a charge to operations.  This
comparison is performed annually or more frequently if circumstances change that
would more likely than not reduce the fair value of the reporting unit below its
carrying amount.
  During the quarter ended December 31, 2008 we
reevaluated our goodwill, due to adverse changes in the economic climate, a
49.5% decline in our market capitalization from October 1, 2008 (our annual
testing date), and a downward revision in our earnings guidance for the quarter
and year ended December 31, 2008.  These factors signaled a triggering
event, which required us to determine whether and to what extent our goodwill
may have been impaired as of December 31, 2008.  The first step
of this analysis requires the estimation of our fair value, as an entity, and is
calculated based on the observable market capitalization with a range of
estimated control premiums as well as discounted future estimated cash
flows.  This step yielded an estimated fair value for us which was
less than our carrying value including goodwill at December 31,
2008.  The next step entails performing an analysis to determine
whether the carrying amount of goodwill on our balance sheet exceeds our implied
fair value.  The implied fair value of our goodwill, for this step was
determined in the same manner as goodwill recognized in a business
combination.  Our estimated fair value was allocated to our assets and
liabilities, including any unrecognized identifiable intangible assets, as if we
had been acquired in a business combination with our estimated fair value
representing the price paid to acquire it.  The allocation process
performed on the test date was only for purposes of determining the implied fair
value of goodwill with neither the write up or write down of any assets or
liabilities, nor recording any additional unrecognized identifiable intangible
assets as part of this process as of December 31, 2008.  Based on the
analysis, we determined that the implied fair value of goodwill was $32.4
million, resulting in a goodwill impairment charge of $167.0
million.  The goodwill impairment charge had no effect on our cash
balances.
  During the quarter ended March 31, 2009 we reevaluated
our goodwill due to continued adverse changes in the economic climate, a 32.5%
decline in our market capitalization from December 31, 2008 through March 31,
2009 and a downward revision in internal projections.  These factors
signaled a triggering event, which required us to determine whether and to what
extent our goodwill may have been impaired as of March 31, 2009.  The
allocation process performed on the test date was only for purposes of
determining the implied fair value of goodwill with no assets or liabilities
written up or down, nor any additional unrecognized identifiable intangible
assets recorded as part of this process.  Based on the analysis, a
goodwill impairment charge of $33.3 million was recorded to write off the
remaining balance of our goodwill for the quarter ended March 31, 2009. The
goodwill impairment charge had no effect on our cash balances.  We
conducted the 2009 annual evaluation of goodwill for impairment and determined
that there was no impairment at October 1, 2009.  We determined there was
no triggering event at December 31, 2009 and March 31, 2010 which could require
an impairment analysis.
 
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  Classification and Fair Value Measurement of
Auction
Rate
Securities
  We hold investments in auction rate securities having
contractual maturities of greater than one year and interest rate reset features
of between 7 and 35 days. These auction rate securities were priced and
initially traded as short-term investments because of the interest rate reset
feature.  During 2008, as a result of the deterioration in the credit
markets, our auction rate securities failed to trade at auctions due to
insufficient bids from buyers.  The credit market crisis led to
uncertainty surrounding the liquidity of our auction rate security investments
and required us to reclassify our auction rate securities to long-term
investments.  In June 2009, due to our ability to liquidate these
securities within the next twelve months, we reclassified our auction rate
securities to short-term investments on our Consolidated Balance
Sheet.   These securities will continue to accrue interest at the
contractual rate and will be auctioned every 90 days until
sold.
  Due to the failure of the auction rate market in early
2008, UBS AG and other major banks entered into discussions with government
agencies to provide liquidity to owners of auction rate securities. In November
2008, we entered into an agreement (the “UBS Settlement Agreement”) with UBS AG
which provides us (1)  with a “no net cost” loan up to the par value
of Eligible ARS until June 30, 2010, (2)  the right to sell these auction
rate securities back to UBS AG at par, at our sole discretion, anytime during
the period from June 30, 2010 through July 2, 2012, and (3) UBS
AG the right to purchase these auction rate securities or sell them on our
behalf at par anytime through July 2, 2012 (See Footnote 3 – Investments of
the Notes to Consolidated Financial Statements).  Following the
execution of the UBS Settlement Agreement, we determined that we no longer had
the intent to hold the ARS until either maturity or recovery of the ARS
market.  Based on this unusual circumstance related to the execution of the
UBS Settlement Agreement, we transferred these investments from
available–for-sale to trading securities and began recording the change in fair
value of the ARS as gains or losses in current statement of
operations.   As of March 31, 2010, our auction rate securities,
which were acquired through UBS AG, had a par value of $11.3
million.
  Contemporaneous with the determination to transfer the
ARS to trading securities, we elected to measure the value of our option to put
the securities (“put option”) to UBS AG under the fair value option of FASB ASC
825, “Financial
Instruments.”  As a result, at December 31, 2008, we recorded a
non-operating gain representing the estimated fair value of the put option and a
corresponding long-term asset of approximately $2.2 million.   At
December 31, 2009, the put option’s estimated fair value decreased to $1.4
million.  At March 31, 2010, the put option’s estimated fair value
decreased to $1.0 million resulting in a non-operating loss of $0.4 million for
the three months ended March 31, 2010.  The estimated fair value of the put
option as of March 31, 2010 was based in part on an expected life of three
months and a discount rate of 0.75%. In June 2009, due to our ability to
exercise our put option within the next twelve months, we reclassified our put
option to other current assets on our consolidated balance sheet.
  As a result of the transfer of the ARS from
available-for-sale to trading investment securities noted above, we also
recorded a non-operating gain for the twelve months ended December 31, 2009 of
approximately $0.8 million. The recording of the loss relating to the decrease
in the fair value of the put option and the recognition of the gain in the ARS
resulted in an overall net loss of less than $0.1 million for the three months
ended March 31, 2010.
  We anticipate that any future changes in the fair value
of our put option under the UBS Settlement Agreement will partially be offset by
the changes in the fair value of the related auction rate securities. Our option
to put the securities under the UBS Settlement Agreement will continue to be
measured at fair value utilizing Level 3 inputs as defined by FASB ASC 820,
“Fair Value
Measurement and Disclosure”, until the earlier of its maturity or
exercise.
  The fair values of our auction rate securities are
estimated utilizing a discounted cash flow analysis or other types of valuation
models as of March 31, 2010 rather than at par. These analyses are highly
judgmental and consider, among other items, the likelihood of redemption, credit
quality, duration, insurance wraps and expected future cash flows. These
securities are also compared, when possible, to other observable market data
with similar characteristics to the securities held by us. Any changes in fair
value for our auction rate securities, which we attribute to market liquidity
issues rather than credit issues, are recorded in our statement of
operations.
   Self-Insurance
  We are self-insured for the majority of our health
insurance costs, including claims filed and claims incurred but not reported
subject to certain stop loss provisions. We estimate our liability based upon
management’s judgment and historical experience. We also rely on the advice of
consulting administrators in determining an adequate liability for
self-insurance claims. Self-insurance accruals totaled approximately $0.4
million and $0.6 million as of March 31, 2010 and December 31, 2009,
respectively. We continuously review the adequacy of our insurance coverage.
Material differences may result in the amount and timing of insurance expense if
actual experience differs significantly from management's estimates.
  
 47
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  Accounting
for Share-Based Compensation
  Share-based compensation expense recognized during the
period is based on the value of the number of awards that are expected to vest
multiplied by the fair value.  We use a Black-Scholes option-pricing
model to calculate the fair value of our share-based awards. The calculation of
the fair value of the awards using the Black-Scholes option-pricing model is
affected by our stock price on the date of grant as well as assumptions
regarding the following:
  •
              Volatility
      is a measure of the amount by which the stock price is expected to
      fluctuate each year during the expected life of the award and is based on
      a weighted average of peer companies, comparable indices and our stock
      volatility. An increase in the volatility would result in an increase in
      our expense.•
              The expected
      term represents the period of time that awards granted are expected to be
      outstanding and is currently based upon an average of the contractual life
      and the vesting period of the options. With the passage of time actual
      behavioral patterns surrounding the expected term will replace the current
      methodology. Changes in the future exercise behavior of employees or in
      the vesting period of the award could result in a change in the expected
      term. An increase in the expected term would result in an increase to our
      expense.•
              The
      risk-free interest rate is based on the U.S. Treasury yield curve in
      effect at time of grant. An increase in the risk-free interest rate would
      result in an increase in our expense.•
              The
      estimated forfeiture rate is the rate at which awards are expected to
      expire before they become fully vested and exercisable. An increase in the
      forfeiture rate would result in a decrease to our
  expense.
  In
certain instances where market based, performance share awards are granted, we
use the Monte Carlo valuation model to calculate the fair value.  This
approach utilizes a two-stage process, which first simulates potential outcomes
for our shares using the Monte Carlo simulation.  The first stage of
the Monte Carlo simulation requires a variety of assumptions about both the
statistical properties of our shares as well as potential reactions to such
share price movements by our management.  Such assumptions include the
natural logarithm of our stock price, a random log-difference using the Russell
2000 stock index and a random variable using the specific deviations of our
returns relative to the returns dictated by the CAPM model.  The
second stage employs the Black-Scholes model to value the various outcomes
predicted by the Monte Carlo simulation.  The resulting fair value, on
the date of the grant (measurement date), is being recognized over the vesting
period using the straight-line method.
   Accounting
for Income Taxes
  We are subject to income taxes in the U.S. and various
foreign countries.  We record an income tax provision for the
anticipated tax consequences of operating results reportable to each taxing
jurisdiction in compliance with enacted tax legislation.  We account
for income taxes in accordance with FASB ASC 740, “Income
Taxes,” which requires that deferred tax assets and liabilities be
recognized using enacted tax rates for the effect of temporary differences
between the book and tax basis of recorded assets and
liabilities.  ASC 740 also requires that deferred tax assets be
reduced by a valuation allowance if it is more likely than not that some portion
or all of the deferred tax asset will not be realized.
  The realization of the deferred tax assets is evaluated
quarterly by assessing the valuation allowance and by adjusting the amount of
the allowance, if necessary. The factors used to assess the likelihood of
realization are the forecast of future taxable income and available tax planning
strategies that could be implemented to realize the net deferred tax assets. We
have used tax-planning strategies to realize or renew net deferred tax assets in
order to avoid the potential loss of future tax benefits.  In
addition, we operate within multiple taxing jurisdictions and are subject to
audit in each jurisdiction. These audits can involve complex issues that may
require an extended period of time to resolve. In our opinion, adequate
provisions for income taxes have been made for all periods.
  Our determination of the level of valuation allowance at
March 31, 2010 is based on an estimated forecast of future taxable income which
includes many judgments and assumptions primarily related to revenue, margins,
operating expenses, tax planning strategies and tax attributes in multiple
taxing jurisdictions.  Accordingly, it is at least reasonably possible
that future changes in one or more of these assumptions may lead to a change in
judgment regarding the level of valuation allowance required in future
periods.
  
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 Item 3: Quantitative and Qualitative Disclosures about
Market Risk
  Market
risk represents the risk of loss that may impact our financial position due to
adverse changes in financial market prices and rates. Our market risk exposure
is primarily a result of fluctuations in interest rates and foreign currency
exchange rates. We do not hold or issue financial instruments for trading
purposes.
   Foreign
Currency Exchange Risk
  For the
three months ended March 31, 2010, approximately 77.7% of our total revenue was
comprised of sales to customers in the United States.  A key component
of our business strategy is to expand our international sales efforts, which
will expose us to foreign currency exchange rate fluctuations. A 10% change in
the value of the U.S. dollar, relative to each of our non-U.S. generated sales
would not have resulted in a material change to our operating
results.
 
 At
March 31, 2010, approximately 46.3% of our cash and cash equivalents was
denominated in foreign currencies.   While we believe we have
implemented a strategy to mitigate foreign currency risk, changes in foreign
currency exchanges rates in future periods will continue to affect our financial
position and results of operations as it is reported in U.S.
Dollars.
 The financial position and
operating results of our foreign operations are consolidated using the local
currency as the functional currency. Local currency assets and
liabilities are translated at the rate of exchange to the U.S. dollar on the
balance sheet date, and the local currency revenue and expenses are translated
at average rates of exchange to the U.S. dollar during the period. The related
translation adjustments to shareholders' equity were a decrease of $0.6 million
and $0.9 million during the three months ended March 31, 2010 and the year
end December 31, 2009, respectively, and are included in other comprehensive
loss. The foreign currency translation adjustment is not adjusted for income
taxes as it relates to an indefinite investment in a non-U.S.
subsidiary.
   Interest
Rate Risk
  The
primary objective of our investment activities is to preserve principal while
maximizing income without significantly increasing risk. Some of the securities
in which we invest may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate.  To minimize this risk in the future, we intend to maintain
our portfolio of cash equivalents and short-term investments in a variety of
securities, including commercial paper, money market funds, government and
non-government debt securities and certificates of deposit. Our cash
equivalents, which consist solely of money market funds, are not subject to
market risk because the interest paid on these funds fluctuates with the
prevailing interest rate. We believe that a 10% change in interest rates would
not have had a significant effect on our interest income for the three months
ended March 31, 2010 and 2009.
   Item 4: Controls and
Procedures
  Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 as of the end of the period covered by this
report, or the Evaluation Date.  Based upon the evaluation, our
principal executive officer and principal financial officer concluded that our
disclosure controls and procedures were effective as of the Evaluation
Date.  Disclosure controls and procedures are controls and procedures
designed to reasonably ensure that information required to be disclosed in our
reports filed under the Exchange Act, such as this report, is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms.  Disclosure controls and procedures include
controls and procedures designed to reasonably ensure that such information is
accumulated and communicated to our management, including our chief executive
officer and chief financial officer, as appropriate to allow timely decisions
regarding required disclosure.
  In connection with this evaluation, our management
identified no changes in our internal control over financial reporting that
occurred during the most recent fiscal quarter that materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
  
 
 49
 Table of Contents
 
 PART
II: OTHER INFORMATION
  Item 1: Legal
Proceedings
  On August
27, 2007, a complaint was filed and served by Kenexa BrassRing, Inc. against
Taleo Corporation in the United States District Court for the District of
Delaware.  Kenexa alleges that Taleo infringed Patent Nos. 5,999,939
and 6,996,561, and seeks monetary damages and an order enjoining Taleo from
further infringement.
  On May 9,
2008, Kenexa BrassRing, Inc. filed a similar lawsuit against Vurv Technology,
Inc. in the United States District Court for the District of Delaware, alleging
that Vurv has infringed Patent Nos. 5,999,939 and 6,996,561, and seeks monetary
damages and an order enjoining further infringement.  This lawsuit has been
consolidated with the Kenexa BrassRing, Inc. versus Taleo Corporation
lawsuit.
  On June
25, 2008, Kenexa Technology, Inc. filed suit in the United States District Court
of Delaware against Taleo Corporation for tortious interference with contract,
unfair competition, unfair trade practices and unjust enrichment. On August 28,
2009, Taleo filed an amended answer and counterclaim against Kenexa BrassRing,
Inc. asserting copyright infringement against Kenexa by the users accessing the
Taleo system on behalf of Kenexa’s recruitment process outsourcing customers.
Kenexa seeks monetary damages and to enjoin the actions of
Taleo.  Taleo seeks monetary damages and to enjoin the actions of
Kenexa.
  On
November 7, 2008, Vurv Technology LLC, sued Kenexa Corporation, Kenexa
Technology, Inc., and two former employees of Vurv, who now work for Kenexa , in
the United States District Court for the Northern District of
Georgia.  In this action, Vurv asserts claims for breach of contract,
computer trespass and theft, misappropriation of trade secrets, interference
with contract and civil conspiracy.   Vurv seeks unspecified monetary
damages and injunctive relief.
  On June
11, 2009 and July 16, 2009, two putative class actions were filed against Kenexa
Corporation and our Chief Executive Officer and Chief Financial Officer in the
United States District Court for the Eastern District of Pennsylvania,
purportedly on behalf of a class of our investors who purchased our publicly
traded securities between May 8, 2007 and November 7, 2007. The complaint filed
on July 16, 2009 has since been voluntarily dismissed.  In the pending
action, Building Trades United Pension Trust Fund, individually and on behalf of
all others similarly situated alleges violations of Section 10(b) of the
Securities Exchange Act of 1934 ("Exchange Act"), Rule 10b-5 promulgated
thereunder and Section 20(a) of the Exchange Act in connection with various
public statements made by Kenexa.  This action seeks unspecified damages,
attorneys’ fees and expenses.
  On July
17, 2009, Kenexa BrassRing, Inc. and Kenexa Recruiter, Inc. filed suit
against Taleo Corporation, a current Taleo employee and a former Taleo
employee in Massachusetts Superior Court.   Kenexa amended the
complaint on August 27, 2009 and added Vurv Technology LLC, two former employees
of Taleo and two current employees of Taleo.   Kenexa asserts
claims for breach of contract and the implied covenant of good faith and fair
dealing, unfair trade practices, computer theft, misappropriation of trade
secrets, tortious interference, unfair competition, and unjust
enrichment.  Kenexa seeks monetary damages and injunctive
relief.
  We are
involved in claims from time to time which arise in the ordinary course of
business. In the opinion of management, we have made adequate provision for
potential liabilities, if any, arising from any such matters. However,
litigation is inherently unpredictable, and the costs and other effects of
pending or future litigation, governmental investigations, legal and
administrative cases and proceedings (whether civil or criminal), settlements,
judgments and investigations, claims and changes in any such matters, could have
a material adverse effect on our business, financial condition and operating
results.
   
 50
 Table of Contents
 
 Item 1A: Risk Factors
  In addition to the other information set forth in
this Form 10-Q, you should carefully consider the factors discussed in Part I,
Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended
December 31, 2009 which could materially affect our business, financial
condition or future results of operations.  The risks described in our
Annual Report on Form 10-K for the year ended December 31, 2009 are not the only
risks that we face.  Additional risks and uncertainties not currently
known to us or that we currently deem to be immaterial may also materially
adversely affect our business, financial condition and future results of
operations.  There have been no material changes from the risk factors
previously disclosed in Item 1A of our Annual Report on Form 10-K for the year
ended December 31, 2009 .
  Item 2: Unregistered Sales of
Equity Securities and Use of Proceeds
  Not
applicable.
   Item 3: Defaults Upon Senior
Securities
  Not
applicable.
  
 Item 4: Submission of Matters to a Vote of Security
Holders
  Not
applicable.
   Item 5: Other
Information
  Not
applicable.
   Item
6:  Exhibits
  The
following exhibits are filed herewith:
  31.1    Certification
by Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).
  31.2    Certification
by Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).
  32.1    Certification
Furnished Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
   
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 SIGNATURES
  Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
  May 10,
2010
 Kenexa
Corporation
  /s/
      Nooruddin S. Karsan
                ----------------------------
                Nooruddin
      S. Karsan
                Chairman
      of the Board and Chief Executive Officer
                
                
                /s/
      Donald F. Volk
                -----------------
                Donald
      F. Volk
                Chief
      Financial Officer
   
  
 52
 Table of Contents
 
  EXHIBIT INDEX
  
  Exhibit
      Number and Description
 
 Exhibit
31.1    Certification by Chief Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a).
  Exhibit 31.2    Certification by
Chief Financial Officer Pursuant to Rule
13a-14(a)/15d-14(a).
  Exhibit 32.1    Certification Furnished Pursuant to 18
      U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.